Changing Venture Capital Investment amidst COVID-19
INTRODUCTION
COVID- 19 has wreaked havoc across all nations. Whether it be socially,
politically, or economically, no nation has completely escaped its
clutches. Nation-wide lockdowns and social distancing measures have
bought paradigm changes across various industries regardless of their
type. With the domestic economies of the nations severely affected and
receiving setbacks, many industries are struggling to adapt to the “new
normal” whereas others have gracefully embraced the changes.
The pandemic has taught us that consumer preferences, habits, and
expectations are very dynamic. Companies need to constantly innovate
in order to satisfy consumer demands and stay ahead of the competition.
Many of these companies depend on a steady inflow of venture capital
(VC) funds.
VENTURE CAPITAL OVERVIEW
Venture capital is a form of finance that is used to meet the needs of
startups and emerging firms, which show promising growth
opportunities. These firms generally lack the ability to generate funds
internally. They usually do not approach banks, due to the inability to
give collateral. VC firms often provide for the liquidity needs of these
companies/firms by investing in them on a medium to long-term basis.
In exchange, they get an equity stake in the respective company/firm.
This helps them to scale up their production and earn more profits. After some point in time, the VC will exit in order to profit from their initial
investment.
With the arrival of the COVID- 19 pandemic, the VCs have described it as
the “Black Swan” and has bought changes to the paradigm of VC
investment. Investment activity dropped significantly in Q1 of 2020 due
to uncertainty in the markets due to the COVID-19 outbreak. However,
equity investments remained steady for the rest of 2020, with the amount
of fundraising surpassing the amount in 2019. So how is VC investing
changing?
Strategic Decision Making
Capital requirements of startups will go up considerably since not only do they have to increase sales and target new customers, but also have to retain existing ones, particularly in the aftermath of COVID-19. This will be particularly in direct consumer-based startups that will be coping with fluctuations in consumer behavior and demand. Thus VCs will now have to be more strategic, making sure any new investments align with their risk appetite, exit strategy, and expected return on investment (ROI). They would have to be realistic with growth expectations from startups
Algorithmic Investing
COVID-19 has caused severe disruptions across all startups and business enterprises, with the level of disruption varying across all. Thus VCs will have a hard time pinpointing the exact timeline of an investment. Due to a lot of uncertainties, the traditional method of algorithmic investing will not work. Investors will have to rely on their intuition in order to identify promising and successful ventures. VCs might enter into strategic partnerships with companies like Oddup which help VCs in providing analytical information on startups, their trends, and their current and expected future valuations.
Shift In Focus
As businesses adapt to the “new normal”, this has resulted in mass digitization of existing processes. Businesses around the globe are now dependent on cloud-based technologies and services so that employees have access to corporate networks. While there are a lot of opportunities for digitization, this has also given rise to a large number of hackers and data breaches. Employees at home might not have the same type of internet security that they get at their workplaces, making them extremely vulnerable to any type of attack.
Thus VCs now are looking at cyber security and artificial intelligence (AI) based startups that aim to eliminate these vulnerabilities.
Cyber security is a priority even for large corporations which hold private data. E.g banks and insurance firms etc. They will be willing to invest in technologies that can quickly identify and respond to threats. VCs will be actively looking for business-to-business (B2B) startups that can offer advanced data analytics and cloud-based cyber security services, which can improve the overall security of corporations, and help in seeking out stopping threats and protecting against any malicious activity.
New Sectors
Not all sectors of the economy have been suffering losses due to covid- 19. Sectors such as healthcare, fin-tech, artificial intelligence (AI), and e-commerce have seen positive growth as a result of COVID-19. Thus VCs will be looking to invest in startups coming up in these sectors. They will be also looking to invest in startups addressing long-term challenges like climate change and food security.
Change in Outlook
COVID-19 will also end the traditional habits of VCs focusing solely on the growth trajectory of startups as a potential for investing. VCs often seem to ignore other metrics while finalizing investment deals, the most important being profitability. Startups often use a large amount of money from fundraising to achieve hyper-growth. They try to maximize their customer base and expand operations quickly; however, they are on a deficit in terms of profit.
VCs will be looking for startups that are more sustainable, resilient, and focus on profit rather than hyper-growth.
CASE STUDY:
Changing VC Investment In China
VCs in China have now been focusing on the Chinese consumer discretionary sector after the saturation of the internet market. The value of these VC deals in the first half of 2021 has already reached $11.9 billion. This has surpassed the values of 2020 and 2019. (according to Prequin).
The resilience of Chinese consumers, innovative brand strategies, and growing purchasing power of the youth have appealed to the VCs. Investors believe that a new generation of founders has emerged who are applying their expert knowledge of branding, marketing, product development, and digital tools to their consumer-based startups and are on the path of becoming fast-growing enterprises. All of these have caught the eye of VCs.
Here is an example of a company Popmart that received funding from VCs.
Popmart is a successful company whose business model works on capitalizing on a consumer’s demand for a gamified experience. They sell their toys in “blind boxes” not letting the consumer know what they are purchasing. They raised $676million with an IPO in Hong Kong and claim $126.3 billion in revenue.
VCs have also been investing in skincare companies in China. Cathay Capital recently invested in a skincare company that achieved monthly sales of $3 million within 8 months. The company focuses on integrating Chinese culture and herbal formulations along with excellent social media marketing.
CONCLUSION:
VCs are gradually changing their traditional methods of investing and moving on to more modern and sophisticated methods. The advent of the COVID-19 pandemic slowed down VC investments; however, it also opened new ventures for investing. Overall the VC industry had a strong performance which was consistent with low systematic risk.
SOURCES:
https://generationt.asia/ideas/how-covid-19-has-changed-the-way-venture-capital-firms-invest
