VC in the Time of Corona

As both a founder and an investor, I’ve received numerous calls and messages recently from founders in Israel looking to better understand the local investor thinking given the global COVID-19 pandemic. I decided to dig in to some research to provide guidance in these challenging and fascinating times.

Many founders are understandably confused and even stressed.

To alleviate some of the confusion and bring transparency and data to founders and investors alike, I’ve spent a couple of days doing phone interviews with VCs who are active in the Israeli tech ecosystem.

My conversations were aimed at gathering data about investor mindset and sentiment, and were conducted under the promise that the data shared would be anonymized and non attributed, to encourage maximal openness.

Founders, I hope you find the data and advice below useful.

The data

  • Calls with 22 different VCs and Corporate VCs investing in Israel
  • All are decision-makers: VC GPs or CVC Investment Committee members
  • A mix of Israeli funds and US funds with a local operation
  • A mix of stage focus, but more weighted towards early stage (seed, A, B)
  • Conversations took place from Tuesday, March 23 to Sunday, March 29

Open for Business…

The good news is that VCs in Israel are open for business.

Nearly all of the funds surveyed reported they are still actively looking at deals. The rest, while assuming a more passive posture, still indicated that they’d opportunistically invest if an exceptional deal came along.

Are investors actively looking for new deals? Or holding back for a while?

Despite planning to stay active in the market, most investors said they’d probably be taking fewer initial meetings (or, more likely, calls). However, this seems to be driven less by reduced appetite and more by external factors, mostly:

  • GPs allocating more of their time to support existing companies
  • Challenges coordinating calls with parents working from home alongside their kids

Most investors expressed the belief that meeting pace would pick up once people and families settle into the cadence of working from home with kids.

… but not Business as Usual

While it’s clear from the data that VCs in Israel are open for business, it’s equally clear that “business” looks different today than, say, 3 months ago.

My first observation from the data is that the fund’s age is key in how investors think about capital allocation at this time.

Most of those who are managing relatively fresh funds reported making no change in allocation between money for new deals and reserves for supporting their existing portfolio.

Conversely, investors at the tail end of their funds indicated making changes to their initial / reserve balance. Most seem to be taking a defensive stance, reserving additional capital to support their existing portfolios. The other, smaller group is playing offense, allocating more capital than planned for new checks, which they expect will yield better returns.

Based on age, are funds shifting allocations towards initial checks or reserves?

Regardless of where funds are in their lifecycle, it is clear from my chats with investors that a big change is upon us. This change in can be summarized as fewer, slower, lower.

While not framing reality in terms of the number of deals they might do in the near future, most investors stated that the bar for new investments is higher. Significantly. The quote below captures the current sentiment:

We’re no longer in a market where any decent team with a deck saying “cyber” raises money with few questions asked

- Early stage investor surveyed

When discussing the new bar, investors mostly mentioned:

  • Markets they know well, and are comfortable with investing into now
  • Really good, experienced teams with a previous relationship
  • Companies or teams they’ve been actively tracking for a long time

Most investors alluded to the fact that they expect new deals to progress slower than in the past. The key reasons cited for this change were:

  • Investors spending more time on existing portfolios and therefore less time on running or supporting live processes
  • Extra logistical challenges for meeting coordination, stemming from quarantine and parents working from home alongside kids
  • A slight relaxing of competitive dynamics resulting from everyone in the market operating under similar adverse conditions

This is perhaps where consensus was strongest: all participants believe that valuations will be adjusted down, in some cases aggressively, for all new rounds happening in the foreseeable future, reflecting an anticipation of economic slowdown and increased general uncertainty.

In ten cases, investors said they were already seeing adjustments, either in portfolio companies being priced by outsiders or in deals they were doing.

Reported valuation reductions ranged from 10% to 40%, with a median of 25% and mean of 23.7%.

A few notes on the figures above:

  • The data set is relatively small (only 10 samples), although it probably represents a fair portion of the live deals in the Israeli market today
  • Anecdotally, adjustments seem to depend on both the stage of the company and the sector it operates in
  • Almost all deals in question are live deals, meaning they were priced recently, during a period of local maximum for investor uncertainty

There’s still a ton of money looking for opportunity out there. It’s just a matter of risk. That is to say: a matter of valuation.

- Later stage investor (not surveyed), early last week

How Long?

Perhaps the key question on both founders’ and investors’ minds is: when will things get back to normal?

While it’s definitely too early to say anything about the broader global financial situation, I asked the investors I spoke with to estimate when will early stage investor appetite bounce back to pre-COVID-19 levels?

From the answers, it’s clear that investors fall into two categories:

  • The relative optimists, who believe appetite will come back towards the end of 2020, or beginning of 2021
  • The relative pessimists, who believe it will take the early stage investment market two years to recover, perhaps longer. For this group, this appears to be more of an “if” question than a “when” question.
When do investors believe early stage investor appetite will bounce back?

In my opinion, the realities represented by these two groups aren’t necessarily mutually exclusive: it’s very likely that, while short-term recovery will be fueled by fresh funds putting their capital to work, the next cycle of VC re-ups will see fewer, smaller funds, and the overall market will contract.

So, What Should Founders Be Doing?

In light of all this, what should you, the founders, be doing differently as you’re talking to investors? Here are a few pieces of advice:

First, remember that all of the adjustments and predictions above are strongly affected by sentiments and moods that swing, sometimes on a daily basis. But, volatile as they may be, these sentiments have a very real impact, most notably on investment decisions and terms.

Here are three key developments that will likely dictate the pace of market recovery, and shape investor sentiment, in the near future. They are worth tracking and understanding:

  1. At what pace will the US get things under control? In this respect, the next few weeks’ worth of numbers and pictures from NY are critical.
  2. Will we be seeing a second wave of mass infections in China after the first wave subsided, and if so, how bad it will be?
  3. How quickly will scientific and medical breakthroughs be made, and how effective will these be in changing in-force containment paradigms?

To state the obvious, you can’t go into a pitch meeting/call and not address the quarantined elephant in the room. Here’s what the investors I spoke with expect to see that’s different:

  1. Be realistic and thoughtful: investors are already quite cynical about how founders contextualize their pitch to the current situation (see the quote below). Remember that VCs are long-term investors. In your pitch, present your long-term thesis on the impact of the coronavirus on your market, and don’t shy away from discussing the harsh near-term operating reality.
  2. Present a longer budget and plan: six months ago, companies were raising money in 18–24 month cycles (12–18 to operate + 6 to fundraise). Today, wary of an adverse financing market in the medium-term, most investors are looking for 24–30 or even 36 month plans. Given the state of the global economy, many of them believe in a more balanced approach emphasizing business health at the expense of growth.
  3. Revise your go-to-market assumptions: with the very basics of daily human interaction changing, it’s safe to assume that even the most tried and true GTM strategies will yield mixed results in the foreseeable future. Make sure you address this in your pitch and adjust your plan accordingly. Relying on high-touch sales? How will the cancellation of conferences and travel restrictions impact your pace? Shipping a freemium consumer app? What will conversion rates look like in an economy with 25% unemployment?
  4. Investor empathy: as both founder and investor, I know that founders have it harder than investors do. Full stop. But investors, especially ones with portfolio companies in sensitive positions, are still in very stressful situations. And just like founders, they are now forced to juggle their personal, family, and professional lives through a chaotic daily routine. Recognize that the person you’re engaging is also, well, a person. Embracing your commonalities will make processes smoother and lead to stronger, more successful relationships.

Every company tells me it’s the best thing to ever happen to them. Feels like Corona is the new AI…

- Early stage investor surveyed

As the data suggests, investors are playing a very different game than they were even a month ago. And this “new normal” is likely to persist for at least a few months. Therefore, my advice for founders would be to adapt, the sooner the better:

  1. Patience: whether it’s internal reasons like VCs spending more time with their portfolio companies or external ones like extra constraints on scheduling meetings, investment processes will take longer than they used to. I suspect that most investors will be more brittle during the next few months: if you push them to make a decision prematurely, they are more likely to come back with a “no”. So take a breath and avoid doing that.
  2. Valuation: the era of rosy valuations is over, at least for the time being. Regardless of whether recent valuation levels were warranted or not, it’s indisputable that they’ve become a major vanity metric for both founders and investors (those who got in at lower prices, anyway). Founders will receive term sheets valuing their company at X only weeks after their friends with similar metrics had theirs valued at 1.5X. It sucks, but in the reality of an outlier-driven market, it also doesn’t really matter.
  3. Allocation: some investors will be playing defense for a while, allocating more of their capital to existing portfolio companies over new deals. Do your research and know the funds you’re engaging (online DBs, SEC filings, and fund announcements are all good sources). If the fund is on the older side (2018 vintage and earlier), don’t be afraid to ask investors tough, direct questions. It’s better than spending time and effort on a process that’s unlikely to succeed.
  1. Get leaner faster: investors will be funding companies for longer with more or less the same amount of money. A 24–30 month plan on the same budget means 25–33% reduction in monthly burn compared to 18–24 month plans. Founders have to learn to do more with less.
  2. Earn your burn: condition increases in expenses and hiring on milestones in your roadmap. It’s important these milestones be well-defined to prevent “burn creep” in a tumultuous financing market. This will allow you to stay on top of your runway and tie your spend to your performance.

Whether we’re headed for a “mere” global economic slowdown (at best) or a full-blown recession (at worst), nearly all sectors will see a drop-off in activity levels for at least a few quarters.

The silver lining is that times like these are great for focusing on product, building out the company’s assets, and preparing for the eventual momentum of a recovering market:

  1. Increased product focus: fewer, longer customer conversations mean you’ll have fewer external pressures on your product roadmap. This allows you to focus on longer-term initiatives that would normally be de-prioritized or under-resourced.
  2. A (slightly) relaxed hiring market: with recent events, the sad reality is that some tech companies will let go of talented employees, while others will shut down completely. Many investors I spoke with said they were anticipating a small talent wave washing the market, and a slight correction in salaries all around.
  3. Investor focus on product milestones: with funds having capital to deploy into markets with fluctuating activity levels, many investors are beginning to talk about a shift in focus from business milestones to product milestones. This is a good time to educate your investors about your product vision and the larger opportunity.

I was hesitant to bring up this last point, because it could be somewhat controversial in a “raise all you can when you can” industry. Having said that, this topic came up in more than a handful of conversations, so I think it’s important to create common knowledge around it.

If you’re a founder who hasn’t taken any money yet, and you’re looking to raise your company’s first round… maybe wait a few weeks. Even if you think you’ll be successful raising now.

The thinking behind this advice is that while things may deteriorate economically in the next month or two, there’ll be more visibility about where they might end up. The decreased uncertainty will lead to more informed, productive conversations around plans, budgets, and milestones.

You may be excited to start, now that everyone’s saying “this is a great time to start a company”. That’s true, but it will remain equally true a month or two from now.

Stronger Together

From personal experience, the founder journey is one of the loneliest experiences a person can have. Despite support from parents, children, friends, spouses, or co-founders, times like these still make the journey lonelier and more challenging.

Having said that, I cannot help but end this post on a positive note: the chats I’ve had in recent weeks with founders, employees, and investors filled me with incredible optimism. Everyone I talked to made me feel a true sense of camaraderie and expressed a genuine willingness to help.

For my part, I’d like to do the same: if you’re a founder (or team) who feels the need to chat for some advice or even just to vent, I’d be happy to find some time to talk with you. Feel free to email me at yuval.ariav@gmail.com

Enjoyed this post? Check out the next one in the series, which discusses the Corona Quadrant Model and what strategy founders should adopt given their company’s situation.

Finally, I’d like to thank the investors who took a few minutes from their chaotic schedules these days to chat and contribute to the community:

Jonathan (LionBird), Tal (Lightspeed), Guy (Harel Insurance Company), Guy (TPY Capital), Avichay (lool), Tal (Dynamic Loop), Liad (Emerge), Lior (M12), Liron (Meron Capital), Tal (Crescendo), Eden (Aleph), Tomer (Viola Fintech), Aviad (Vertex), Omry (Viola Ventures), Ben (Amiti), Philippe (Square Peg), the folks at Bessemer and Ofek, and a couple more who asked to remain nameless.

… and the people who gave indispensable feedback: Racheli Kogan, Roee Nahir, Megan Groves, Elad Raz, Iftach Ariav and Taly Rabinerson.

Cheers!

VC, Founder, ex-CTO @Fundbox, ex-Product Chief @Onavo (acq. Facebook), Adj. Professor @Columbia. I get sh*t done. #winandhelpwin

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