Survival of the Fittest: COVID-19’s Impact on Venture Funding

How Should a VC Investment Strategy Pivot During the COVID-19 Crisis Based on Past Downturns?

When the economy takes a turn for the worst, a few things usually take place. Market multiples contract. Unemployment rises. Cash dries up. For many startups, this will mean death. For others, clamping down on burn quickly, becoming hyper efficient, and continuing to execute — even at reduced growth rates — will help them make it out the other side.

Over the past 12 years, many companies received funding due to an increase in the number of funds, which were raised relatively easily thanks to the lower cost of capital. In the coming years, however, startups and venture firms will be challenged. As a result, Darwin’s survival of the fittest will come to fruition, and only a limited number will survive.

With the emergence of the COVID-19 pandemic, funding dollars, funding rounds, and private company valuations will all decline. Given the uncertainty emanating from Silicon Valley and the venture community, we thought it’d be fascinating to go back in time and track valuations of companies that raised around the ’08-’09 time frame and ended up becoming successful.

Who Are the Fittest?

Granted, this analysis is biased for upside and not illustrative of the long list of companies that failed and closed shop during this period. It also does not encompass every company that generated a return for its founders and investors. However, the results are intriguing, with far more companies successfully emerging from the ’08-’09 downturn than we had anticipated:

Note: Red font denotes flat / down rounds, decreases in valuation, or subpar exits. Green font denotes up rounds, increases in valuation, or positive exits.

Suffice it to say, you were hurting in the short-term if you were an investor that came in on the Series B for Coupa or the Series C for Carbon Black and witnessed valuations take a nosedive in the subsequent round. Valuations and pricing require extra consideration in economic downturns.

However, it’s also evident that both of those companies — and many of the others in the above image — went on to become quite successful. With companies like Mulesoft, AppD, Tableau, Box, and Facebook generating outsized returns, investors would be remiss to close their doors.

Here we see flat / down rounds with companies such as Lending Club and Docusign. We also see up rounds with companies such as Twitter and Zynga. Investing at the same valuation as an investor two years prior might signal a well-placed bet. To the contrary, valuation at exit would seem to signify prioritization of getting into the right companies above all else.

In our final set of companies below, we see that several seed rounds were completed in the midst of the last recession, including Airbnb, Slack, Lyft, Pinterest, and Okta.

Additionally, Veeva was able to make only $7 million in total funding last through the downturn and to its eventual IPO in 2013. The epitome of vertical software, Veeva’s tailored features and highly targeted marketing efforts within life sciences led to improved SaaS metrics, such as lower CAC and best-in-class retention, and a $20B+ valuation today.

Invest Strategy Is Not One-Size-Fits-All

VCs will need to focus on portfolio companies, maintain reserves, and increase rigor around diligence and post-investment execution. Beyond that, however, the above data would suggest that VCs should continue to invest with three key tenets in mind:

1. Early-stage works. These are companies with scrappy teams who can keep burn low while focusing on product and UI. Examples include Slack (seed in 2009), Twilio (seed and series A in 2009), and Zscaler (series A in 2008).
2. Later-stage works. These are category winners that may be attractively repriced as they continue to alleviate massive pain points. Examples include Coupa (series C in 2009), Box (series B-1 in 2009), and Carbon Black (series C-1 in 2010).
3. Be price-sensitive albeit flexible. Some companies have the leverage to abstain from valuation haircuts, even in economic downturns. Investors who remain dogmatically rigid in pricing may miss these opportunities. Examples include Tableau (acq by Salesforce for $15.7B), LinkedIn (acq by Microsoft for $26.2B), and ServiceNow (current market cap of $50B+).

Doing Our Part as a VC Community

As we enter this period of uncertainty, many VCs will be focused on their portfolio companies, modifying plans via reductions in top line, headcount, and burn. Difficult decisions will be carried out as a result, and we empathize with those who are being negatively impacted by this pandemic. The inevitable constant, however, is that startups will continue to emerge in need of funding.

Rather than shut our doors, the VC community should embrace this uncertainty by investing in and helping to grow the next generation of category creators and disruptors. Investors must stay amenable, adjust on the fly, and look to deploy. In getting this next set of great ideas funded now during this downturn, we’ll have helped create the foundation for a new set of leaders to thrive and tackle pain points we so direly need solved.

We will inevitably be on the cusp of another bull cycle in due time. Let us seize the opportunity to drive that cycle forward and support the courageous entrepreneurs enabling a better tomorrow for us all.

Data was pulled from Pitchbook and Crunchbase.

Note: An increase in pre-money is not always indicative of an increase in share price. Thus, pre-money can increase while a subsequent round is still considered a flat or down round.