Founders all over Europe are, understandably, freaking out. It’s hard enough to raise money in a healthy economy, let alone when the stock markets are tanking globally.
Over the past week venture capital investors, from prominent US venture capital firm Sequoia through to newer European funds like Angular Ventures, have been sharing advice with their portfolio companies about how to weather the situation.
Many are calling for startups to slow down or stop hiring, slash spending, work from home, cut out travel — and prepare for tough times ahead.
Yet that’s little comfort to founders mid-fundraise — or with a short runway of cash — who are now wondering if, not when, they’ll be able to close their next rounds.
Will VCs stop investing?
“Definitely not!” says Ophelia Brown, a partner at venture capital firm Blossom Capital. “We just signed [a term sheet] last week and expect the next one is imminent.”
“We are open for business,” says Evgenia Plotnikova, partner at Dawn Capital, adding that Dawn portfolio companies have raised close to $200m this week.
Matthew Stafford, an angel investor in the UK, says he’s “carrying on as normal for now”. He has just invested in one company (for the third time) and is beginning due diligence on another.
Other investors are less enthusiastic, however.
“There will be fewer FOMO rounds.”
“There are a lot of funds out there with a lot of capital to deploy, but they have years to do it. VCs can and will slow down,” says Paul Murphy, a partner at Northzone. “I think there will be fewer FOMO rounds because investors will take a bit more time to get to know and diligence the business, and I don’t think that’s a bad thing.”
Which companies will be most affected?
“The best companies will still get funded,” says Murphy. “It might take them a few extra weeks, and they might get a few less term sheets to use as leverage, but they’ll be fine.”
Companies that have recently raised, or have more than six months of runway, should also be fine, says John Spindler, a seed investor and chief executive of London-based entrepreneur support organisation Capital Enterprise.
However, pre-seed and seed-stage startups with less cash in the bank, he fears, “will find it almost impossible to raise an interim round, as their burn rate will increase as sales fall”.
It is likely to be harder than usual for these companies to gain customers, meet potential clients and start showing traction. In turn, this is likely to make it more difficult for them to raise the next round of funding (later-stage VCs like to see milestones being hit) — and they will need to raise that round sooner than expected.
“The best companies will still get funded.”
“There’s a small group that are potentially great businesses, but need an extra six months to prove that,” Spindler says.
Meanwhile very early-stage companies might also be fine, he adds. “They can put off starting for three months — their only cost is themselves.”
Sifted reader Michal Krčula is one such founder. “I was just about to start approaching investors after more than four years of development of my product,” he says. “I guess that at this time the best thing to do is to focus on completing the product and then return to searching for a partner in a month or so, even if it causes a delay going live.”
Other Sifted readers at early-stage startups told us they weren’t feeling too many negative effects yet, with preliminary meetings with investors still going ahead — albeit via video call.
VCs will become more selective
“The bar is higher,” says Christopher Priebe, partner at Global Founders Capital. “The next round will be harder than it was a year ago.”
“The next round will be harder than it was a year ago.”
VCs may also focus efforts on their best-performing portfolio companies.
“The honest but not very popular answer here is most funds reserve 50% of their capital for follow-on investing and the intention is to use those reserves to double down on the most obvious winners, not to bail out questionable companies,” says Murphy. “So if this downturn persists or becomes more severe, all VCs are going to have a handful of ‘good’ but not yet ‘great’ companies that they need to make tough calls on.”
Fundraising winners and losers
Some investors (those who have recently raised funds or still have lots of capital to draw down) will benefit from the situation.
“It’s an opportunity,” says Priebe from Global Founders Capital: he’s looking at offering a £500,000 round extension to one startup which he didn’t manage to invest in at its last round.
“VCs are extra interested in how our business is now growing because of the pandemic.”
It’s also an opportunity for the lucky few startups finding increased interest in their services as a result of the coronavirus pandemic. “VCs are extra interested in how our business is now growing because of the pandemic,” says Joost Bruggeman, founder of Siilo, a communication tool for medical professionals, who is currently raising a Series A.
He says Siilo has seen “a surge of inbound requests since the outbreak, even in regions we’re not dominant in” and sales cycles have dropped from 18 months to two weeks since just last week. Bruggeman is confident he will be offered more favourable term sheets than he may have been otherwise.
That won’t be the case for all companies. Founders who take investment over the next few months are likely to raise at lower valuations, and part with more equity.
But Capital Enterprise’s Spindler doesn’t think that investors offering companies in a tricky situation capital over the next few months will be taking advantage of them. “It’s easy to back a company that’s growing month-on-month that you missed,” he says. “But to fund one that’s stalled, with revenue declining, where the team’s still good but affected by coronavirus… Well done to those [investors]. They should be celebrated.”
Convertible notes — a form of short-term debt which converts into equity at the next funding round — is one option for companies running low on cash.
It’s a way for investors to loan money to a startup before it begins a full-on funding round, to be converted into shares on a given date or at the next fundraise.
In a LinkedIn post, Spindler calls for someone to step forward to offer these convertible notes. It would help out some startups in a tight spot — and could be lucrative for the organisation offering the loans, too. “People will make money out of them,” he says.
“The British Business Bank should step up, or investors should all come together — but they won’t,” adds Spindler. “They’ll all look after themselves.”
There are other forms of financing available. Uncapped, a London-based company offering loans to startups to use on marketing, says it has “seen a marked increase in applications” in recent weeks.
“Revenue-based finance has the benefit that if a company’s revenues slow, so do repayments, making it a friendlier alternative to traditional funding, especially in less certain times,” says Uncapped cofounder Asher Ismail.
Governments and public bodies could also step up. At the moment, Innovate UK, an organisation which funds innovation, pays startups in arrears. “This is an emergency — get them to pay it forward,” says Spindler.
Likewise, research and development tax credits in the UK are also paid to startups after they have spent money. “Speed it up: if a company’s got a track record, give them the money in advance,” suggests Spindler.
The French government has announced measures to support early-stage businesses. Startups affected by coronavirus can request an extension to their social security and business tax payments, and obtain (or extend) loans from the public bank, Bbifrance.
Startups can also try to spend less — and carefully think through how revenue may be affected in the coming months.
“CEOs should consider a range of scenarios on revenues and a range of scenarios on spending. In the best case, for example, perhaps some moderate spending cuts take place and revenues are not impacted too heavily. On the other hand, if revenues dramatically slow (or fail to grow), but spending is kept at the original plan, that might result in a dramatically shorter runway,” says Gil Dibner, partner at Angular Ventures.
Sifted reader Andrey Davtchev, chief executive of Matrax, a mattress company based in Bulgaria, has taken several practical steps to protect his business. “We’ve done a stress test analysis for what happens to profitability if sales fall by 25% or 50% and we have identified how we can cut costs accordingly to remain profitable,” he says. “Since our goods arrive from Italy, we have ordered additional stock in case of supply chain disruption.”
Matrax has also put several cash-draining projects on hold, trimmed down on marketing and frozen non-essential hiring.
How to look after your team
It’s easy for investors to recommend founders ‘do more with less’, but when you’re the person faced with firing staff, that’s a whole lot harder.
There are alternatives to letting team members go. Founders and employees could all take a pay cut, and founders could compensate employees with more share options. Investors will need to sign off on such measures — but they should do so, says Spindler.
“Cut (particularly senior) salaries,” suggests angel investor Matthew Stafford. “If people are working from home and not going out to socialise then most can live on less for a short period.”
“CEOs need to keep their companies alive — all of this needs to iterate and be under constant review,” he adds. “They’ll have to make some tough decisions and they need to show their teams that they can lead them through this. It will end; they need to hunker down and get through it.”
How is your startup being affected by coronavirus? What steps is your company taking to cope with the situation? Let us know: email [email protected].