Hey, it’s Scott Orn at Kruze Consulting, and today we’re talking about three factors that are slowing startup investment by VCs, and we’re right in the middle of the COVID-19 situation, so this is an up to date market report here. But, there’s three things that are really happening.
The first is venture capitalists have big portfolios of existing companies, and so when there’s a crisis, they spend a ton of time working on their existing portfolio, helping those companies survive, so they’re in a lot of board meetings doing things like maybe redoing the operating model or maybe doing headcount reductions or just strategizing on how to get into a different market, and also maybe strategizing on how to raise more money. And so, VCs are essentially distracted from doing new deals right now because they’re doing their job. They’re working with their existing portfolio companies. That’s what you want them to do, but it does slow down the amount of new deals they can do.
The second factor is capital calls become more difficult in tough times like now. Now, thankfully, the stock market has recovered from the March and early April reductions, and so now the asset basis for all the pension funds and endowments is back up pretty much to where it was. So, capital calls are not as painful as they were maybe two or three weeks ago. When the market goes down a lot, it’s very difficult for the foundations, endowments, pension funds to fund the capital calls. They will do it. They’re contractually obligated to do it, but that means they’re selling stuff at the bottom. They don’t like selling assets for low prices either, just like you and I, and so when VC firms submit their capital calls, that means they’re selling an asset to fund that capital call, and so they’re much happier funding that capital call when things are good, the stock market is up because they’re liquid and they’re not taking a price discount. So, in March and April, when things were really tough in the stock market, they were not super happy. Again, they were funding capital calls, but they might’ve had some words or maybe told the GPs to be a little more conservative. Now, venture capitalists, it’s not really in their best interest to talk about that. They’re not gonna publicly advertise that their LP said slow down the capital calls. But, that does happen. I’ve been through it. I worked at a venture capital fund. I’ve seen it happen. It definitely happens. The LPs are really, as a VC, your customer, and so you’re gonna do what they want. You’re gonna be very respectful of that relationship.
The third thing that’s slowing down venture capital investing right now is price discovery. We just don’t know, no one in the legal system knows what a company is worth today versus we had a pretty good idea where the economy was six months ago, pre-COVID. The stock market was working. It was efficient. We could see that valuations for SATS companies usually traded in like a five to 10 X revenue multiple. That’s kinda what the market was, for example, SATS companies. But, VCs had a pretty good idea of what a series A should go for and how much capital should be raised in a series B and a series C, and so on.
Now, with COVID, there’s so much confusion and diversions in a company’s performance and the stock market isn’t super rational right now either that venture capitalists don’t have a good feel for what the true valuation of a company would be. And so, if they get too aggressive, they may look foolish down the road. Say someone gives a super aggressive term sheet to a hot company right now, they may feel, you know, a little bit silly down the road because their LPs may really ask them what they were thinking doing such an aggressive deal in times of COVID. And so, venture capitalists are in this process along with founders of price discovery.
Everyone is doing a lot of negotiations and trying to figure out what the new prices for series A, series B, even angel investments are, and that takes a little while to work out. It takes some stability in the stock market. It’s a lot easier, if the market’s lower, it’s just easier if it stays a bit lower for a while for people to get used to the new reality. When it’s bouncing around with thousands of points drops and increases, it’s very confusing to everybody. So, venture capitalists, they’re fiduciary. They’re fiduciary for the funds that invested in them, and so they wanna make sure they do a good job and make sure they get in at a fair price, and so price discovery is what’s holding up some of the deals too. So, just to recap, the work on existing portfolio companies is taking a lot of time. The trying to be conservative on capital calls is also slowing down investment, and the third thing is price discovery.
Once we get to a more stable time, even if COVID is still a factor in our life, those three things will settle down and venture capitalists will start doing more deals. Hope that helps, thanks.
source
