Venture Capital post-COVID-19: trends in the entrepreneurial and investment environment

So what’s next? The entrepreneurial and investment ecosystem has not been spared by the coronavirus. In recent years, despite an environment of uncertainty and political-economic tensions, great progress has been made in Venture Capital, both nationally and internationally.

A large number of new businesses came to fruition, while more financing transactions and for larger amounts were carried out, with more and more mega-rounds (over 100 million euros).

Specifically, in 2019 Spanish startups attracted a total of 1,208 million euros. The strength and maturity of the European entrepreneurial market was also confirmed as a source of talent and job creation, and the gap with Silicon Valley was narrowed, although the US continues to dominate the Venture Capital market (capturing more than half of the investment in 2019).

COVID-19 is a turning point that brings about change for investors and entrepreneurs. At InnoCells, we have detected new dynamics that could be consolidated in the coming months:

Change in the pace of investment activity

How will they adapt? In general, there is less momentum in the investment pool and more risk aversion, although with certain nuances depending on the type of investor.

As a result of the coronavirus, the Venture Capital industry is expected to be affected on a global scale, something that began to be perceived in the first quarter, particularly in terms of the number of transactions. Although it will be offset by a large volume of dry powder in the market (with a capital concentration in high-conviction deals), many investors will be waiting to see the real impact of the pandemic.

It should be noted that this reduction in investment activity, either because some ongoing rounds have been halted or postponed and priority has been given to closing ongoing deals, has been offset by increased monitoring and portfolio re-evaluation activity. We have gone from laissez-faire VC to a more involved VC: through more interactions and greater support activity in fundraising, business generation, etc.

And in the corporate environment? In the first quarter of 2020, financing via corporate investment vehicles (Corporate Venture Capital) decreased compared to the end of 2019. This trend is expected to continue and greater efforts will be made to ensure the sustainability of the core business (operating costs control), with a smaller allocation of capital for investments.

Business angels will also be less active as the expected return on their investments in stock markets, real estate exposures, etc. will be affected. On the other hand, as a result of the impact on downward valuations, less traditional and more distressed-oriented investors may begin to enter the field.

We are facing a change of paradigm in which VCs could gain negotiating power due to the lower flow of capital, a benefit that entrepreneurs had until now.

However, investors are not expected to alter their allocation strategies: there is still interest in alternative assets, thanks to the good positioning of VCs in the digital ecosystem and their ability to take advantage of the increasing adoption curves in the transition from the offline to the online world.

New dynamics in investment processes

The growth of the Venture Capital industry was largely driven by increased foreign investment. In 2019, 19% of investment rounds in European companies included a US investor. Travel restrictions are expected to cause cross-border venture capital investment to decline in the second and third quarters of 2020.

How will this affect Due Diligence? Difficulties in conducting them face-to-face will reduce much of the foreign activity with some VCs in favour of a more domestic focus. While some transactions may be carried out, the process and timeframe for investment will be lengthened by the need to create new work methodologies and dynamics. For example: in the early stages, even if the investment tickets are smaller, meeting the team or visiting the company’s facilities is a key element.

Therefore, during the last few years, a decrease in the proportion of capital allocated to early-stage investment (seed) has been observed. It is expected that this shift will be accentuated in the coming months and that investors will bet on more established and more mature companies.

With few IPO windows, many companies will try to build bridge rounds to obtain funding while the market turbulence lasts. That is, many companies will opt for smaller amount rounds versus the desired round, in order to ensure they get to the next round, especially when the expected metrics have not been met at earlier stages (e.g., to go from seed to Series A).

It seems that the delay in IPOs could be offset by mergers and acquisitions, driven not so much by loose cash positions, but by transactions with a more defensive approach, such as cost synergies.

There are also new investor sensitivities and perceptions about valuations, which in many cases include a downward review. Valuations of more mature companies will be affected by adjustments in cash flow projections and the allocation of a higher cost of capital. On the other hand, valuations of more embryonic companies, with no history on which to make projections, will be more sensitive to falls in associated demand.

Startups will have to adapt to the new normal

In this new phase, there is a clear need among entrepreneurs to expand runway ranges (the months a company can operate until it exhausts its available cash position). If before it was 12 months, now the forecast will be extended to 18–22 months and, due to the uncertainty, there will be more difficulties in making business plan estimates. As regards fundraising, this new environment may be an opportunity for some VCs to join companies which they were unable to join in the past (oversubscribed rounds): entrepreneurs may be in touch again for future rounds.

This is a time of changing priorities due to the increased focus on profitability by investors (breakeven times, burn-rate control, etc.). Startups will bet on both pivoting their business models and modifying the scope of their roadmaps, with a less ambitious approach, and will postpone strategic decisions. In addition, capital efficiency will become more important than growth, and remuneration via equity may tend to increase in an environment of falling salaries.

Finally, in recent months, a greater convergence between the public and private sectors has been perceived. On the one hand, a significant number of startups have been pushed to apply for measures and stimulus packages from public bodies, while, on the other hand, the investment community is analysing new co-investment scenarios (ICO, CDTI, EIB, etc.).

At InnoCells, we have offered all the necessary support to the companies in our portfolio over the last few months. We are active again in the market to support startups of different verticals and to carry out mutually beneficial partnerships. If you want to share your project with us, contact us at investments@innocells.io.