Venture Capital and COVID-19: Conversations with Investors

As director of Finaves, the micro VC managed by IESE Business School, my first reaction to understanding the implications of this unprecedented and unpredictable crisis in Finaves’ portfolio and future investments, was to read, listen, and ask professionals in the sector whose good work inspires my confidence.

During the last few weeks, I have had the opportunity to talk with eight VC partners and one LP, specifically the European Investment Fund. The number is not big enough to be a representative sample for any study or statistic, but my conversations have shed some light on how COVID-19 is affecting the VC sector and how VCs are reacting to it.

Here are some of the main conclusions of these conversations, along with direct quotes from some of the investors that I found particularly illuminating:

1. The crisis will produce (is producing) a significant adjustment in valuations, to reflect lower sales forecasts as well as higher discount rates due to greater uncertainty and volatility.

  • The first two months will reflect a fall in the number of transactions, and afterwards we will see significant adjustments in valuations.”
  • “Instead of price adjustments, we will play around with scenarios and ratchets. If the entrepreneurs reach the promised milestones, we will maintain valuations.”
  • “In this new situation, entrepreneurs have to understand that, in many cases, we are not returning to the valuation of the last round but to valuations in the range of seed rounds.”

2. Inverse effect on funds’ profitability: Vintage funds lose, new funds win

  • Funds recently raised will continue to invest, but those close to the end of their investment period will allocate dry powder to follow-ons in portfolio companies.”
  • “Vintage funds will be the losers of this crisis. They have invested at higher valuations and they may need to increase their life terms in order to exit from all their investee companies.”
  • “We will see good returns on investments in 2021 as valuations will be adjusted.”

3. Rebalancing of funds, capital injections and other mechanisms to save portfolios … or not 

  • “We are seeing many funds rebalancing their portfolios using dry powder to follow on investments.” (European Investment Fund)
  • “We are studying new mechanisms to increase liquidity in the system by injecting new funds into existing funds and creating new vehicles to co-invest with existing funds increasing the size of the rounds.” (European Investment Fund)
  • “Many funds are reviewing their reinvestment clauses in order to reinvest funds from exits instead of distributing them to their LPs.”
  • “The first measure we have taken is to stop everything and protect the cash of our investees by reducing expenses and obtaining the maximum financing available from the government for this crisis.”
  • “We do not make any extraordinary reserves for follow ons. This means that we will let some of them fall. We have to take into account the opportunity cost of not investing in a new and lean project.”

4. Opportunity to restructure balance sheets and P&L of existing (sometimes oversized) companies

  • “This crisis brings a good opportunity to some companies to exchange short-term debt for long-term debt (thanks to the new financing measures approved by the government) and for companies to reduce expenses and be leaner.”

5. The market will dry up during 2020 …

  • “I don’t think we will be making new investments over the coming months, unless they are opportunities that we were already studying. For us the personal relationship is important, we do not believe in virtual relationships.” (Three different investors made this same observation.)

6. But will come back strong in 2021 with new funds and new players …

  • We have just raised a new fund and we will continue investing.”
  • “We are going to close the third fund despite the situation since we already had most of the LPs  already committed.”
  • “There is so much dry powder in the market that I foresee big investment activity in 2021.”
  • “As interest rates stay low, there will be more liquidity for corporates and venture debt.”

6. In bigger rounds and leaner companies

  • “New investments will go to more solid structures with longer runaways (+18 months). This implies bigger rounds, more debt and more co-investment. Also more dilution for entrepreneurs.”
  • “Crisis years are known for creating new investment opportunities which are born leaner than startups created during prosperous years.”

7. Great investor appetite for companies that accelerate technological changes and in particular for telemedicine

  • “The crisis can be an opportunity for digital companies.”
  • “This crisis is going to accelerate the digitalization of many sectors and companies. Companies that help this transformation will benefit from this crisis. ”
  • “Technology is the great winner of this crisis. While the stock markets are falling, Nasdaq is at pre-crisis values.”

As you can see, our experts do not have an entirely negative outlook. As in other conflicts, there are always opportunities behind a crisis. We also see some light on the horizon, particularly those with the shape of startups that quickly and without consuming significant resources can help to boost a technological acceleration already underway.