Venture Capital Outlook For 2020 A Qualitative Scenario Analysis

Investor thought process and where it leads us during COVID times

As days roll by, global pandemic induced by the novel coronavirus is getting more and more complex. The pandemic has exposed the mankind's shortcomings. On a positive side, it has showcased the potential of humans to come together during these testing times.

COVID 19 has caused a great uncertainty and fear in the financial markets. As the financial indices have taken a nosedive in the last couple of months, all other asset classes have also taken a toll including real estate, corporate bonds and fixed deposits. Even safe heavens like gold and silver are also facing the heat with the emergence of “Cash is the King” scenario.

While the early-stage ventures and early-stage investors are also facing similar situations, but their interpretations and responses can make a great difference.

Our discussions ecosystem players indicated varied thought process yet a light at the end of the tunnel and positivity. We thought of penning down the emerging points from the investor perspective as part of our analysis of the current scenario.

Investors are still open for business :

Majority of the VC’s and seed funds around the world are continuing, though at a slower pace, to evaluate the investment proposals and continue to be active. The focus has shifted partially towards focusing on existing portfolio companies for crisis management. Some of the them have taken a passive stance but continue to look at any extraordinary opportunity that comes along.

The count of meetings and number of proposal evaluation has reduced with a more microscopic approach in terms of evaluating the proposal. As highlighted earlier, the key factors driving the slower pace are :

  • Focusing on their own portfolio companies : Portfolio companies are facing the same situations as all of us, this requires a lot of focus on the part of the investor to guide them through this crisis;
  • Investors are now more prudent with their cheque books. Evaluation of a proposal is more in-depth and founders who understand this will be able to spearhead their fund raise successfully; and.
  • Working from home is not equally efficient : Working from home surrounds any individual with a lot of inefficiencies, home chores and managing responsibilities. Lack of maids, kids alongside, various calls lined up are adding up which are critical for everyone to manage as well.

Fund managers who are managing relatively newer funds (fund age < 2 years) are not changing their allocations between investing in too new deals and reserves for supporting their existing portfolios. While funds which are at the end of their life cycle are more inclined to make changes in their allocations. These funds are taking a defensive stance and are more inclined towards supporting their existing portfolio companies.

All in all, we can conclude that the investors will be looking at fewer deals, slower TAT and lower valuations.

1. Fewer deals : Over the years evaluation of an early stage venture has revised and in recent years the funnel has narrowed out. Meaning that the bar has been raised significantly higher for new investments. Investors are now more interested in:

  • Markets they know well and are comfortable with. This can also be a signal towards a more sector specific approach from a sector agnostic approach
  • Focus is primarily on the team –Excellent founding teams, with experience and previous relationship
  • Companies or teams they’ve been actively tracking for a long time.

2. In-depth evaluation process resulting in higher TAT :The current market will lead to a higher TAT for new deals as compared to the past. Key reasons behind this are :

  • Investors spending more time with the existing portfolio companies thus less focus on new investments opportunities
  • Extra logistical challenges are stemming from social distancing and quarantine.
  • Relaxed competition in the market. Competition between investors has relaxed and has provided investors with the breathing space to take time in completing their respective deals.

3. Lower Valuations :

  • Investors and founders believe that the valuations will be adjusted downwards, aggressively in some cases.
  • The onset of the economic slowdown and increased general uncertainty has resulted in increased risk premiums on private label investments.
  • This will lead to lower valuations at all stages and rounds.

We can expect an adjustment and correction of about 30% on average to valuations across. There is still a lot of money with investors who are looking to invest in an idea and scale it up, but the risk is comparatively high as ever as compared and hence lower valuations.

How long will it take for investor activity to get back to normal is very hard to predict? Some investors believe that by 2021, everything will be back to normal while some are expecting a longer-term impact somewhere in between 18-24 months.

One thing is sure that existing funds will work more prudently, and short-term recovery will be based on them.

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In continuation of this, we will be summarizing the key emerging points from founder perspective as part of our next blog. Continue reading and stay safe!!

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