Capital markets have been changing, and the Covid-19 effect has been pretty pronounced in several ways. Evan Fisher shares his top five ways that venture capitalists, private equity funds, high net worth investors, and founders are being affected – and what’s coming down the road
Early-stage: it’s tough out there for venture capitalists – but your high net worth individual neighbour might fund you
In Early-stage venture capital (VC), the power has shifted.
Beginning in March, capital flowed out of VC funds as limited partners (LPs) cut commitments or pulled some of their capital. While some may have been benefited from some LP attitude thaws stemming from the summer’s market performance, the damage was already done in Spring. Many VCs’ bank balances were essentially cut in half.
The result? Well, when $250m USD turns into $125m USD overnight, you’re not going to be writing checks half the size – you’re writing fewer of them. And now, founders seeking first-time institutional capital are the hardest-hit, with a substantial increase in competition at the same time as other existing VC-backed businesses had their cap-raise plans accelerated.
Contrast this with another interesting development: we’re seeing a huge increase in high net worth individual activity in VC. Sure, they most likely won’t lead your round, and the check size will probably be smaller, but it’s very interesting.
We’re hearing anecdotal evidence of high net worth individuals saying: ‘I pulled out of the market in March and have been sitting on cash since then – show me an outstanding deal in VC now, because I’m actively writing checks!’
So, even though institutions are hurting, early founders are raising very willing capital from high net worth individuals.
Another interesting development: your target VC may be moving. In a trend that began as a trickle and turned into a flood, VCs have relocated from the heart of Silicon Valley across the Bay and even across the country to greener pastures as they ride out the pandemic.
It makes sense: after all the founders went home, why does a VC need to physically hang out at the corner coffee shop? With VCs decentralised, their employees and portfolio founders working from home, it’s actually easier to get an audience these days.
In later-stage and private equity, exit timelines are getting pushed out
Indisputable: for most sectors, 2020 is the ‘lost year’. The financial year 2020 is the hole that nearly sunk the ship, and the gears are still grinding as many struggle to get back into growth mode.
For those businesses’ sponsors, the 2020 exit plans evaporated faster than alcohol-based sanitiser on warm hands. Considering the dragged-out process of getting back to baseline results, they won’t be selling for top dollar in 2021 either.
However, sponsors are mostly holding tight with a view to ride it out. Translation? Exit timelines are getting pushed out as companies that had been flourishing and entertaining a sale process, are now forced to hold off while management run around like overworked firefighters and investors apply the burn cream.
2022 is going to be a big year for mergers and acquisitions.
Tough sector? Deals still happening – but not what founders hoped for.
Within the hardest hit sectors, including retail and travel tech, we are seeing companies striking creative deals. In a market where you’re trying to sell to struggling businesses whose core goals are
- To conserve capital,
- To discontinue non-essential investing and
- To cut staff to avoid capital calls or the threat of bankruptcy
What’s the best approach?
Without the short-term option to raise capital from other companies within their sector or sell their businesses, deals are being made on a budget (read: exiting founders are getting little to no cash up-front, and the vast majority on an earn-out). The core founder strategy? Push that business back into the black, get it into growth mode coming out of Covid-19, and realise the sale as quickly as possible.
This author foresees a wave of private equity-backed retail businesses that have changed distribution strategies & bolted on an acquisition or two coming to market in early 2022 as private equity sponsors say: ‘Let’s get out before we see something like COVID happen again.’
I’ll say it again: 2022 is going to be a big year for M&A.
Some founders just got lucky – and their investors are doubling down
Unsurprisingly, the rich have continued getting even richer. Businesses that happened to be in the right space at the right time are receiving unsolicited offers from VCs (and on the public side, the recovery time objective strategy is very much en vogue). We’re seeing that founders who just ‘got lucky’ have no need to shop around for investors – merely hinting about plans to raise capital are met with enthusiastic interest from existing large shareholders. Why is this happening?
In one company we know of, investors that might have otherwise tapped out, are looking around at the rest of the market and saying: ‘We don’t really like what else is out there – and we’d rather stretch to stick with you.’
These investors are doubling down on what they know is working.
Investor risk aversion is manifesting itself as ‘stick with a story you know.’
For founders, it’s a bird in the hand, too.
All of this is making it even more challenging for fledgling startups to make headway.
Fear of the unknown has also caused a shift within private markets, with capital providers favoring much-more-reasonable deals than we’ve seen in the past.
In the aftermath of WeWork’s overinflated valuation, investors are now (surprise?) being forced to justify their valuation positions, since their LPs have just been reminded that ‘valuations can go down too.’ Capital may not be limited – but the propensity for investor over-enthusiasm is.
This means that the many businesses raising capital are being forced to inject a dose of realism into their cap-raise goals. How are we seeing that materialize?
Strategic deals and intentional valuations are much more the norm these days. This means a lower price tag than pre-Covid (and likely lower than many founders might prefer). But accepting a fair deal is more logical than holding out for a ‘dream valuation’ that’s probably not attainable within the current market. With no expectation of more help from stimulus packages, the focus is now on securing what’s needed to weather the storm for at least the next two years.
Evan H Fisher is the founder and CEO of Unicorn Business Plans, a boutique consulting firm which develops ultra-premium pitch decks, business plans, cap-raise strategies and investor materials for founders and entrepreneurs raising $5-50m USD or exiting their businesses. More information is available on www.unicornbusinessplans.com/work
