What I’m hearing about venture right now

Follow me @samirkaji for my thoughts on the venture market, with a focus on the continued growth with the emerging manager landscape

Over the last few weeks, our daily routines have been disrupted by the continued spread of the novel Coronavirus, and many of us may contract or have loved ones contract the virus. Please stay safe, and take every precaution to stay healthy.

While it’s impossible to accurately project the path of the pandemic, it is safe to say that havoc in the financial markets is a short term certainty — In the last week alone, we experienced a 2,000 point drop in the Dow, and clear signaling that the fed will exercise aggressive monetary policy this upcoming week with a large fed funds rate cut.

As uncertainty brings turbulence to capital markets, I spent the week speaking with fund managers, limited partners, bankers, and companies to get their thoughts on what they were seeing. I’ve synthesized my higher level observations in the notes below.

For Companies:

· Not much change is expected right now in early stage deployment. Every GP I spoke conveyed that they would stay the course and that they did not expect any change in deployment methodology through 2020. They sensed that any slowdown we might experience in the coming months would be a result of logistical (reduced in person touchpoints, travel, etc.), not financial concerns. This sentiment aligns with what we experienced during the Great Recession when deal activity didn’t drop until 18 months after economic instability had begun, and after dry powder levels had atrophied and LP investment activity had reset.

· Seed and A round valuations are expected to hold stable, with only slight drops (I heard 10% by end of summer from a couple of people).

· Many companies with healthy cash reserves are pre-emptively drawing down on existing bank lines. This seemed to be more prevalent at the growth stage; perhaps driven by fears of an upcoming tepid exit environment, a drop in late stage capital availability, and the likelihood of a more dilutive late stage environment where public comps become more relevant. The acquisition environment will be one to watch as many of the bellwether public companies continue to enjoy enormous cash positions.

· Many believed that Corporate VC programs will experience some distress, particularly in programs whose companies are most directly affected by COVID-19.

· Companies are being given guidance to be conservative where possible, re-evaluate burn and runway projections, and to expect 1–3 quarters of missed revenue targets. With regard to burn, the belief is that the time between rounds will start to lengthen in the next 12 months (from 2007 to 2009, we saw time between rounds go from a little over 18 months to just over 24 months).

For VC funds:

· Fundraising time lines are expected to protract greatly for emerging funds, with many funds taking longer to reach targets (Fund I/II offerings may stretch from 17.6 months to 18–24 months) and with # of closes going from an average of 2, to 3–4. I covered this in my post last weekend.

· Many institutional LPs have instituted extended WFH policies and travel moratoriums. They have also asked managers not to visit, opting for calls or videoconferencing.

· Another challenge is widespread cancellation, postponements, or conversions of annual meetings to virtual meetings. Many GPs use annual meetings not only to update LPs and showcase portfolio CEO’s, but to catalyze new fund offerings with new and prospective LPs.

· Most predicted that 2020 VC fundraising would only slightly dip from last year’s total of nearly $50B. This is predicated by the number of large closes completed thus far in 2020 and those expected in Q2.

· Unlike 2009, the “denominator effect” is not a near term concern (this is a phenomenon where an investor becomes over allocated to slower mark to market asset such as venture due to drops in the value of other assets that are quicker to devalue). However, it is clear that planning sessions to stress test various economic scenarios have begun.

· In speaking with several family offices, it seemed clear that they are slowing activity in privates, and many are taking a slow, wait and see approach. This is definitely happening and will significantly, in the short term, affect the raises of those managers reliant on this type of capital.

· The secondary market is expected to shift toward buyers, both with respect to LP stakes, and direct positions, particularly if the current economic volatility persists. One manager was able to invest in direct secondary opportunities with discounts ranging from 40–60% of last round value (in performing companies).

· LPs have not yet, but are expected to ask for more visibility into capital call projections and an encouragement to increase cycle time between funds.