11 minute read 21 Apr 2020
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Venture capital before and after the pandemic

By Jeffrey Grabow

EY US Venture Capital Leader

Passionate about working with entrepreneurs and venture capitalists in Silicon Valley and beyond.

11 minute read 21 Apr 2020

Early Q1 2020 venture capital numbers were signaling another strong quarter. Then, the COVID-19 global pandemic appeared. Now what?

First, I hope everyone is safe and healthy; that truly is the most important thing.

In late February, when we started to review the venture capital numbers for Q1 2020, we were well on our way to recording another strong quarter of activity and continuing the trend established in the last decade. Then the mother of all unexpected events appeared — the COVID-19 global pandemic.

In the space of barely two weeks, stock markets plummeted, followed by unprecedented steps to stem the virus’s spread, including bans on cross-border travel and shelter-in-place policies in many of the world’s most developed nations. This resulted in economic activity coming to an abrupt halt at a scale we have never witnessed before.

Venture capital activity

We saw a solid increase in venture capital funding this past quarter. Looking back, we can attribute three reasons for the resilient investment results:

  1. A belief that consumer-oriented sectors needed to get ahead of a potential recession
  2. A resurgence in mega funding rounds from companies that wanted to prepare for winter
  3. The COVID-19 pandemic hit toward the end of the quarter, which allowed many deals to get through the process and close

Results for Q1 2020 finished up from Q4 2019, with $28.9b invested in Q1 2020 vs. $25.5b invested in Q4 2019, a healthy increase of 13%. Looking at sources of capital this past quarter, investment amount increased by 31% and 15% from corporates and venture capital firms, respectively. Although we saw a 25% decrease of investment dollars from private equity investors, over the coming quarters there may be an opportunity for private equity to be more involved if valuation expectations can be managed. To be clear, the bull market in venture capital has ended.

Digging into the round at which venture capital was deployed, we found that 43% of all capital raised last quarter — $11.8b — went to later-stage companies. This is up 11% from the prior quarter.

Mega-round financing

Looking at mega-round financing (a round of $100m and above), we saw an increase of 44% in the number of deals done at this level (62 in Q1 2020 vs. 43 Q4 2019). These rounds raised $15b or 52% of all capital raised in the quarter.

Sector activity

Among sectors, we saw major activity in consumer goods and information technology compared to Q4 2019. The growth in consumer goods was fueled by an extremely large deal of $2.3b in auto technology and $1.3b in food and beverage funding.

The significant investment activity in consumer goods was expected; in anticipation of a potential recession, companies in that sector were being encouraged to ensure they had plenty of capital.

The information technology sector also had a very strong quarter, with $9.6b raised in Q1 2020. That’s the second strongest quarter on record and 33% of total capital raised. The software subsector seems to be the primary driver for the activity. In Q1 2020, 80% of the $9.6b invested in information technology went to this subsector. This is a trend that has played out over a number of years and shows no sign of slowing.

What to do now

We are still coming to grips with the impact COVID-19 will have on our economy, the world and more broadly, our society as a whole. The immediate economic impact has been significant and will hit the venture capital funding market for the next few quarters. It’s safe to say that my prediction in December of 2019 that less than $100b will be deployed in 2020 will likely come true. Naturally, I take no pride in being right under these circumstances.

Everyone wants to know what will happen from here in the venture markets. We expect to see new deal activity slow down and anticipate that investors will reinforce the companies in their existing portfolio, particularly those positioned to grow through their abilities to mitigate the pandemic. In addition, we could also see an infusion of cash for companies struggling to sustain revenue due to reduced economic activity. And finally, many companies will not survive.

The old maxim that cash is king should guide many of your actions for the next several months. Speed to action is critical here. Entrepreneurs need to re-evaluate their businesses and determine the best strategy to deal with and emerge from the pandemic. Consider the following:

  1. Extend your cash runway for as long as possible. Think up to 24 months to be safe
  2. Evaluate your line of credit situation and explore the willingness of existing investors to provide near-term capital support
  3. Challenge your revenue models to understand the impact on cash collections and the expected cash burn needed to support your business
  4. Consider capital management steps, such as putting a freeze on hiring, reducing headcount where necessary and extending terms on large contracts
  5. And if you haven’t already, reach out to your customers to get a sense of how this will impact their operations and whether they intend to delay purchases or extend project

This is also one time when you should not be shy about accepting government aid (see Government Stimulus section). Study the full impact of the rules to see if your company is eligible for loans, particularly those that enable you to retain your employees. Also evaluate tax deferrals and credits being made available.

Looking ahead

Once current portfolios are stabilized and we have a clearer understanding of the overall impact of the COVID-19 crisis, new deals will pick up. Not at the pace we have seen the past three to five years, however. On a positive note, venture capitalists are sitting on an enormous stockpile of dry powder. Investors have raised more than $100b over the past two years and when the timing is right, this capital will be invested.

While there’s no question things are quite challenging now, I am long-term bullish. Innovation and technology driven by venture capital have been transforming our lives at an ever-increasing pace over the past 10 years. I believe there are significant opportunities that still lie ahead. In times like these, the leading entrepreneurs shine and separate themselves from the pack.

That said, we are all hoping that this pandemic is resolved as quickly — and safely — as possible in each state, the nation and throughout the world.

I hope everyone stays healthy and safe. Please practice social distancing so we can reap the benefits of the price we have already paid. And, of course, wash your hands.

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Summary

We are still coming to grips with the impact COVID-19 will have on our economy, the world and more broadly, our society as a whole. The immediate economic impact has been significant and will hit the venture capital funding market for the next few quarters. We expect to see new deal activity slow down and anticipate that investors will reinforce the companies in their existing portfolio, particularly those positioned to grow through their abilities to mitigate the pandemic.

About this article

By Jeffrey Grabow

EY US Venture Capital Leader

Passionate about working with entrepreneurs and venture capitalists in Silicon Valley and beyond.