Raising Capital in the Midst of a Crisis: COVID-19
The economic repercussions of the pandemic have been wide and deep, adversely impacting firms of all sizes and in all sectors across the globe. Startups are faced with their own metaphorical black swan, witnessing their cost of capital double or even triple. Many focused on insider rounds to avoid going to market at lower valuation while others chose to implement drastic cost cutting measures including staff layoffs. Yet, some were left with no option but to consider a premature sale or even file for bankruptcy as a last resort.
Recent well-known examples include WeWork’s sale of Meetup as a standalone business and Uber’s investment in the scooter company Lime at a reduced valuation. In a publicized announcement, Airbnb is stated to raise USD 2bn debt and equity amidst a severe revenue plunge of %50 in March and with quarter of its workforce laid off.
While the VC activity in Europe appeared stable in March and April, closing several big deals such Lilium, Cazoo, and Collibra, these were in the works long before the pandemic. The next few months will provide a better view of how the European startups will weather this crisis. Fortunately, the ecosystem is bearing this crisis from a position of strength, having raised record levels of capital in 2019. Yet, it continues to be skewed more toward early stage investing which is inherently fragile.
Emerging market startups are in a precarious situation as well. To-date, most have been able to survive harsh business climate and limited ecosystem support by building diversification into their geography and product mix. While diversification strategy has proven to be effective for building resilience in emerging markets, it is not a safeguard in a global pandemic with lockdowns in economies worldwide.
Venture, private equity or corporate backers are faced with hard choices as well. The economic fallout of the pandemic forced them to recalibrate compounded risks associated not only with the business model but also with the balance sheet cash and burn position of each company in their portfolio. While some have chosen to walk away, others have been proactive and resourceful, deciding to support the companies in crisis while deferring valuation until later. Rather than opting to raise a full venture round, quick financing through bridge loans and convertible notes have been the preferred route with the expectation that the company can raise equity at a fair rate once the pandemic and its repercussions are over.
The impact has been most pronounced on the saturated segments of technology, such as cloud computing, social media, and streaming companies. Tech companies that have been upheld by huge funding rounds and with strategies that require massive monthly burn rates have been hit the hardest. Any start-up with liquidity problems is likely to have a hard time rising to the challenge since it will be more difficult to put together a presentation book, negotiate with investors, and find an ally within a VC to support it.
On the bright side, already entrenched profitable start-ups with strong balance sheets are simply tightening their belts and continuing with their business. Truly disruptive technologies that enable being social and/or productive at home as well as technology solutions for added digitalization and online business migration, telemedicine, edtech, and cybersecurity firms are seeing an uptick in transactions and may come out of this downturn stronger than before. It is, therefore, not surprising that VC community continues to be on the lookout for deals, albeit cautiously. Especially those with a multi-pronged approach, offering both debt and equity financing appear to be well positioned to capitalize on new opportunities in these challenging times.
Going forward, growth and revenue prospects are likely to be transformed for all start-ups. There is no tried and true playbook for what the post-pandemic “new normal” will be.
The importance of stress-testing of target businesses along with downside protection will increase, especially for early stage investments. Yet; the fundamentals of what constitutes a truly “valuable” start-up will remain the same, reminding us once again the importance of the team with a unique business model based on a disruptive technology and meaningful customer proposition.
