Over the past couple of weeks we’ve spoken to dozens of startup founders, including both portfolio company CEOs and new founders considering raising capital, about the developing COVID-19 crisis and the effect on private capital markets. In these conversations, the same questions keep coming up:

• Should I delay my fundraising plans until the crisis abates?
• What impact will this have on valuations and round sizes?
• Should we consider altering our business plan?
• How can I best position myself to fundraise successfully in the current climate?

The COVID-19 crisis is developing rapidly and there’s no way to know what the future holds, but we can look to history to help answer these questions. Although this period will undoubtedly be different than the recessions of the past, history often tends to repeat itself. [1]

What to expect

Less capital available

After several fundraising-friendly years, VCs are purportedly sitting on three years of dry powder, meaning activity is unlikely to drop off a cliff. However, following drops in the value of their publicly traded portfolios, LPs may find themselves overweight in alternative investments, such as VC, so new LP investments in funds may be limited. Further, with the possibilities of more underpriced liquid equities, there may be plenty of attractive deals outside of VC for them to focus on.

Known as the “denominator effect”, this phenomena was seen in recessions past, and is likely to start impacting startups raising follow-on rounds in the medium-term, with both fewer and ultimately smaller rounds too. This effect may also be augmented by non-traditional participants, such as Corporate VC and Family Offices scaling back their exposure to risk capital.

Longer fundraising cycles

Pitchbook data from 2008 shows that the time between a company’s first and second fundraises peaked at 2.1 years in 2008, compared to 1.7 years in 2010. As investors become more risk-conscious and apply more scrutiny, companies should expect to extend their runway lest they get caught short before the next raise.

Depressed valuations and reduced step-ups between rounds

This is simply a question of supply and demand. As investors become more picky, and with capital for new funds looking increasingly limited in the near future, investor demand may drop. All the while, supply remains relatively constant, resulting in price decreases. Between Q1 2008 and Q4 2010, valuations decreased by 27.3%.

Meanwhile, valuation increases between rounds have also been reduced in recessionary periods, with 2008 valuation step-ups averaging 1.35x vs. 1.6x – 1.8x during non-recessionary periods.

Greater investor selectivity and scrutiny

As economic fundamentals deteriorate, investors will naturally apply more scrutiny to potential investments. Beyond this, VCs will be keen to protect their internal rate of return (IRR). Fund vintages from prior recessions have typically recorded lower IRRs. Even top tier investors have not been immune – Sequoia Capital IX (1999 vintage) and X (2000 vintage) saw -6.1% and -31.0% IRRs, respectively. In order to minimize economic and reputational damage, VCs will likely apply a finer tooth comb to their sourcing and due diligence practices, while deployment cycles will be longer as VCs look to “time diversify”.

Beyond that, investors may well change their sector and profile preferences, no longer tolerating less efficient business models – instead allocating more to profiles such as software, compared to lower gross margin, capital heavy businesses.

Angel, Seed, and Early-stage rounds

While round sizes, valuations and rate of investment activity are likely to decrease, on the plus side, at the Angel and Seed stages activity has historically been robust. Other than a very moderate reduction in deal volume in the second half of 2008, angel and seed deal activity continued to increase. While it’s hard to pinpoint exactly why, it may have been driven by the more altruistic nature of angel investing, and smaller check sizes required at this stage.

Positioning your startup for success

Y Combinator founder, Paul Graham, wrote in 2015 that a startup can be either “default alive” or “default dead”. Put simply, if a startup’s burn rate remains constant, and its revenue growth continues as it has in the months prior, can the company get to breakeven with their remaining cash? If the answer’s yes, the startup is default alive; if not, it’s default dead. In a tougher fundraising environment, investors will understandably be increasingly less likely to fund “default dead” startups.

So be default alive. Here’s a helpful calculator to work out which you are.

How can you improve your company’s profile?

• A leaner operation will diminish burn rate; by reducing your non-core expenses, you can extend your runway and reach profitability sooner.
• Be strategic with your investment decisions e.g. does it make more sense to spend on expensive digital ads in pursuit of rapid growth, or to invest that same money in higher ROI channels with stickier customers?

Beyond that, raise more now while you can. Companies fundraising to extend their runway 12-18 months should now be looking at 18-24 months until the next round. The private capital markets may remain active in the short term, so you can use the opportunity to shore up your balance sheet for the tougher times ahead. Learn more about fundraising on SeedInvest.

Most importantly, stay healthy, wash your hands, and help flatten the virus’ curve by maintaining social distance. Without your health, and that of everyone else, none of the above will matter.

Useful Resources

• What Coronavirus Could Mean for the Global Economy (Harvard Business Review)
• U.S. Department of Labor Offers Guidance on COVID-19 Wage Related Issues (Benesch)
• Emergency Paid Leave Requirements for Private Employers with Fewer than 500 Employees (Benesch)
• Tips for Leading Remotely (Gallup)
• Boosting Immune Health to Protect Against Coronavirus (Blum Center for Health)
• Pandemic Preparedness in the Workplace and the Americans with Disabilities Act (The U.S. Equal Employment Opportunity Commission)
• Coronavirus COVID-19: Facts and Insights (McKinsey & Company)
• Preventing Pandemic Pandemonium: An Employer’s Guide to Practical Strategies (Fox Rothschild)
• How to Effectively Work Remote (Redfin)
• Guidance on Preparing Workplaces for COVID-19 (Osha)
• 5 (Practical) Cs for Leading in a Crisis/Downturn (Scaling Up)
• COVID-19: U.S Business Guide (Medium)
• Business Tips for Navigating this Uncertain Time (Company)
• Google is Allotting Ad Credits for Small and Medium-Sized Companies (Google)
• Coronavirus Emergency Loans: Small Business Guide and Checklist (U.S. Chamber of Commerce)
• Top 100 SBA Lender List (SBA)
• Stroock’s Guide to the CARES Act’s Business Loan Lifeline (Strook)
• Coronavirus (COVID-19): Business Guidance – Pandemic Response Law (Perkins Coie)
• Assistance for Small Businesses (U.S. Department of the Treasury)

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