“A knowledge vacuum”: As COVID-19 causes economic chaos, will startup investment dry up?
COVID-19 is playing havoc with the economy, and a recession is looking increasingly likely. But what does that mean for startups relying on VC investment?
As the COVID-19 pandemic has developed from a health crisis to an economic concern to a recession that’s going to be hard to stave off, the focus of reporting on the economic impact has been on small businesses — cafes, restaurants, tourism operators — that are suffering from the sudden drop in footfall.
But, in the medium term, we’re looking at an ongoing economic slump. And in startupland, that’s likely to have an effect.
Already, we’re hearing stories of startups pulling the plug on funding rounds, suddenly a lot less confident that they will be able to make the returns they had hoped for their investors.
And, in a market where early-stage startups are already deemed risky, and are disproportionately underfunded as a result, the pipeline may be at risk of drying up.
Last week, productivity app startup Drawboard raised $9.3 million in funding, in a round led by US fund Blackhorn Ventures, and tied up all loose ends just before the COVID-19 pandemic really went global.
Other investors included Steve Baxter’s TEN13, plus other family offices and private investors.
Founded in 2014, the startup was not exactly designed for a world of remote working, as we find ourselves in, but it certainly lends itself well to it.
It’s a digital document tool, allowing users to work together on something, remotely or otherwise, and fostering collaboration, while also reducing the need for paper.
Founder Alastair Michener launched the business with two main objectives, he tells SmartCompany.
“To create sustainable logs, and to create — not necessarily remote — but a modern workspace where you can work from anywhere.”
Of course, as the world deals with the spread of COVID-19, and businesses all over Australia implement remote working, this is the kind of product that is suddenly invaluable.
“It’s a terrible time right now, and it just puts the spotlight and attention on all collaboration software,” Michener says.
“It’s our time right now to help.”
But, even though Drawboard got its funding in the door just in time, and has a product that lends itself to a disrupted environment, the spread of coronavirus has forced the startup to put on the brakes.
Michener doesn’t reveal exact figures, but he says the startup is bringing in annual revenues in “seven figures”. Revenues are growing 10% month-on-month, he adds.
This funding round was intended to help the business capitalise on that growth, and expand into the US market. However, that’s no longer a sure thing.
“I was expecting that myself and a few staff here in Australia would be spending quite a lot of time in the US this year,” the founder explains.
“We will just have to monitor that situation as the weeks go by.”
Are investors open for business?
So, was Drawboard one of the lucky ones to sneak in before we see startup investment slow to nothing?
Last week, a TechCrunch report suggested that, in the US at least, while wary investors steer clear of new ventures, there may be a select few hoping to swoop in to support promising, robust businesses that would have had their pick of backers beforehand.
That could mean that, actually, startups with strong growth prospects will still be able to secure funding, albeit at a reduced valuation.
But that’s the US, and this is Australia. It’s a very different market, and it’s early days yet.
Adam Schwab, co-founder of Luxury Escapes and an angel investor, tells SmartCompany the state of the investment landscape of the future will depend on the depth of the crisis, “and the subsequent economic fallout”.
“Bearing in mind we’re coming off more than 20 years of debt-fuelled over-exuberance,” he adds.
Australia doesn’t have the same mature market as the US does, or as many investors to squabble over promising up-and-comers.
“In the short term (and possibly the medium term), the crisis is likely to make the small pool of investors more nervous and wary to invest,” Schwab suggests.
“This will impact both early-stage and later-stage businesses, as well as impact valuations.”
Benjamin Chong, partner at Right Click Capital, tells SmartCompany the VC firm is “still open for business” and actively looking for opportunities.
“We believe that even in these strange times, great companies can emerge,” he says.
In the global financial crisis of 2008 and 2009, for example, there were companies created “that are household names today”.
But, that’s not to say all VCs are doing the same, and Chong acknowledges that startups with deals in the pipeline could be facing new hesitancy from their prospective backers.
“It’s a very fluid situation, and I think if more people get confined to home then it will naturally be more difficult to have meetings with founders, it will be more difficult to conduct due diligence, it will be more difficult to get things done,” he explains.
“There’s a saying in the industry: ‘time kills deals’,” he adds.
“I would suggest that if folks do have term sheets out and are keen to progress, that they try to get the money in the bank sooner rather than later.”
Who’s screwed?
If startup funding does drop off, there’s also some confusion about who it will affect the most.
In Australia, we’ve seen an ongoing trend of the average size of funding rounds increasing, and the average number of deals decreasing, suggesting more and more dollars are going into later-stage rounds that are arguably safer bets for investors.
It would be a fair assumption this is likely to continue, as VCs and private equity firms try to survive the economic downturn themselves, and pump money into businesses that are already big enough to weather the storm.
But, Chong suggests that, actually, startups that are at a relatively early stage, but have secured funding in the past, might not have too much to worry about.
Investors want their portfolio companies to survive. Many have already raised funds that aren’t going anywhere. So it stands to reason that there would be an appetite for follow-on investment.
VCs want the sector they work in to survive — not only because that’s their livelihood too, but because for many it’s their passion.
“We want the people we work with, and the people that we spend time with, and the startup community, to remain as safe as possible,” Chong says.
Conversely, it’s the later-stage startups with high-growth stories that might find themselves suffering.
“I would say the later-stage startups that might be pre-IPO — because the public markets are closed for IPOs and for capital raising — those are more likely to be impacted,” Chong suggests.
“For investors who are writing really big cheques, then there may well be a hesitancy or a slowdown in the activity.”
And what about the early-stage, bootstrapped startups, or those that had been on the lookout for their first seed funding, or an angel investor?
Schwab also notes the “dearth of early-stage funding” in Australia, especially compared to other more mature markets such as the US and Europe.
As an angel investor himself, he says it is, of course, much riskier to invest now. That means it’s a risky time for cash-strapped startups, too.
“Even well-performing early-stage businesses won’t survive if they simply aren’t able to get the necessary funding to get to scale,” he says.
There may be fewer angel dollars around, but that doesn’t mean there will be nobody investing at all. No two angel investors are the same, he notes. But — just as TechCrunch suggested would happen in the US — startups could be looking at decreased valuations.
“Angel investors are not a homogenous group, and it will depend largely on their liquidity levels and risk appetite,” he explains.
“It’s a market, and valuations will ultimately adjust downwards to the point where investors perceive they’re getting a higher return for their higher perceived risk.”
Schwab reiterates that this is early days, and we don’t yet know how bad this economic downturn is going to be. It will certainly be a while before we know for sure what the impact on the startup sector will be.
“Everyone is acting in a knowledge vacuum,” Schwab says.
But, startups should certainly be wary, and consider taking their foot off the pedal for the time being.
“A reduced ability to raise money to fund operations is cause for significant concern,” Schwab explains.
“Startups need to be focused on survival for the next six to 12 months, rather than hyper-growth.”
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