Thriving in a Downturn

Takeaways from my first RAISE event.

A few weeks ago I had the opportunity to attend an event for venture capital emerging managers on the topic of “Thriving in a Downturn”. The event was hosted by the team at RAISE Global in partnership with the folks at Capital Connect by J.P. Morgan. My biggest takeaway? Cortado and many of the firms we work with in the Midcontinent region have been somewhat insulated from the worst effects of the current VC downturn, but we have to stay diligent. The one-day conference was one of the most content-rich events I’ve attended, and I’ve synthesized what I heard from some of the top GPs in the country in the notes below.

Tips for the Downturn

1. Reserve More Than You Normally Would: Portfolio companies will inevitably have a harder time raising funds in a downturn, making it essential for venture capital firms to have sufficient reserves to support their best companies.
2. Be Aggressive: Consider how you might adjust your typical investment strategy to capitalize on opportunities that arise due to a changing market landscape. For example, if valuations are cut in half, consider doubling your target number of investments or doubling your ownership target in each deal. This can help venture capital firms leverage the downturn for more meaningful returns in the future.
3. Monitor Burn Multiple as a Crucial Metric: Burn multiple (calculated as net burn / net new ARR for a given period) measures how efficiently a company utilizes each dollar of burn to generate value. It becomes even more critical during a downturn, as companies need to optimize their spending and extend runway to survive. VCs can monitor the burn multiple of their portfolio companies and work with them to identify and implement cost-saving measures, streamline operations, and identify new revenue streams.

Portfolio Allocation and Management

1. Focus on the Ultimate Goal of Venture Investing: During a downturn, startups will inevitably struggle to stay alive, and both startups and their investors can get overly focused on preventing companies in their portfolio from going under by slowly extending runway. But remember the goal of venture isn’t for a company to just get by; the goal is to generate outsized returns with big wins. A downturn can be a good opportunity for both entrepreneurs and investors to stop and ask — do I still believe this company going to be the big win I thought it was?
2. Don’t Burn Bridges for Vanity Metrics: One of the GP panelists gave an anecdote about a venture investor who wanted to block a bridge round for their portfolio company for two months so the markdown wouldn’t show up on his fund financials until the following quarter. Venture capital is a long game.
3. Funnel LP Co-Investments into Your Best Companies: Providing LPs with co-investment opportunities into some of your best companies is a great way to both hedge and manage reserves. Helping LPs get big wins through direct investments in strong companies can increase the chance of LPs re-upping in your next fund, even if the fund doesn’t perform as well as you hoped.
4. Be Careful with Early Sales Wins from Startups: Always be wary (but especially in a downturn) of early sales wins from your portfolio companies that aren’t selling to sophisticated customers (i.e. startups selling to other startups but unable to get through an enterprise sales cycle). Those early wins from unsophisticated customers can provide a false sense of product-market fit achievement.

Tips for GPs from LPs

1. Help your LPs Understand the World Better: This includes sharing insights and information about the market landscape, industry trends, and potential risks and opportunities. By sharing this information with LPs, GPs can increase trust and build strong relationships, which can be beneficial for future fundraising efforts.
2. Overcommunicate with LPs: During a downturn, overcommunicate with LPs to ensure they stay informed about the firm’s activities, portfolio companies, and market insights. Sending quarterly letters may not be enough, and venture capital firms should consider proactively setting up Zoom call updates to share what they’re seeing in the market and responding to any questions or concerns. By staying transparent and communicative, venture capital firms can strengthen relationships with LPs and increase the chance of re-upping.
3. Understand the Denominator Effect: The denominator effect is a term used to describe the impact of public securities decreasing in value on an LP’s venture allocation. This may make it look like the LPs are over-allocated to venture, but in reality, many LPs have been over-allocated to venture for a while. Take time to get to the bottom of what’s really important to your LPs (and potential LPs) from an allocation standpoint.

Thanks to RAISE and the team at Capital Connect for hosting a great event, and to all the GPs and LPs that took the stage as panelists and contributed these great insights.