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Outlook and Impact of Coronavirus on Venture Capital Investments and Emerging-Growth Companies

Client Alert

Authors: Christopher S. Miller, Thomas P. Dwyer, Stephen M. Fox, Kenneth R. Minturn, Christopher Hagenbuch and Daniel R. Sieck

3/27/2020
Outlook and Impact of Coronavirus on Venture Capital Investments and Emerging-Growth Companies

The combined health and economic crisis caused by the outbreak of coronavirus (COVID-19) and subsequent isolation efforts across the world have left many emerging-growth companies with numerous questions about how to get through this unprecedented turmoil. Below we offer some guidance from around the industry on the present outlook of venture capital investments and some steps that emerging-growth companies can take to come out stronger than ever.

Outlook

The uncomfortable truth is that venture and growth financings will slow dramatically due to public and private market uncertainty, but this does not mean that financings will come to a complete standstill. Venture firms in the United States raised $46.3 billion across 259 fund vehicles in 2019, second only to 2018 totals, meaning that funds have plenty of dry powder that they will need to deploy over the next two to four years. As a result, most high-quality companies will likely be able to obtain funding in this new environment, though the process may take several additional weeks and founders will see fewer term sheets, which they could ordinarily use as leverage. Venture capital firms have noted that they are already negotiating term sheets from start to finish based solely on video conferencing.

High-tech startups without supply chain risk are more likely to see continued investment activity. The life sciences and health care sectors are also likely to come out on top.

Still, emerging-growth companies should prepare for difficult times ahead. Private investments in Q1 2020 are on pace to reach $77 billion, down more than 16 percent compared to Q4 2019 and down nearly 12 percent versus Q1 2019. Many VCs anticipate the market to be soft for at least Q2 and possibly Q3, with more normal conditions returning in Q4. Others see extremely turbulent markets for up to 18 months. Even after extreme conditions subside, valuations are likely to fall significantly, customer uptake will be slower, and M&A will decrease. Some companies are reporting that signed term sheets are already being renegotiated by investors. As a potential leading indicator, China is weeks ahead of the United States in the spread and containment of COVID-19, and China’s venture capital investment statistics show a drop in VC investments to 2013 levels.

Next Steps

It is clear that the private investment market will change significantly, regardless of how long the most extreme effects of COVID-19 last, meaning that emerging-growth companies should take immediate steps to adapt. Sequoia Capital’s “Coronavirus: The Black Swan of 2020” memo urges companies to make the best of a bad situation. The memo asks, “What would you do if fundraising on attractive terms proves difficult in 2020 and 2021? Could you turn a challenging situation into an opportunity to set yourself up for enduring success? Many of the most iconic companies were forged and shaped during difficult times.” These companies include Google and Salesforce (1999-2002) and Uber and Instagram (2007-2010). Sequoia further encourages companies to act quickly and decisively as those that adapt to change quicker are more likely to survive, including looking to raise capital as soon as possible even if not planned.

Venture capital investors are advising portfolio companies to take immediate steps to weather market uncertainty, including sacrificing growth in order to extend cash runways for a period of at least six to 12 months. Mayfield managing director Navin Chaddha is advising companies “to have at least two years of runway and raise the funding they need, without getting too hung up on valuation,” noting that surviving the crisis is more important than valuation.

Jason Green, partner at Emergence Capital, says that it is especially important for companies making less than $10 million in annual revenue to immediately start thinking about capping or lowering burn rates or bringing in financing to continue to grow through this cycle. Specifically, investors are advising companies to revisit business plans, with particular emphasis on cash needs, fundraising plans, financial projections, marketing, headcount, supply chain and capital spending. Companies should not assume that conditions will rebound quickly, but should seek to cut burn rates in order to extend runways until investments pick back up and should anticipate that customers will curtail spending during and after this crisis.

Companies may also be faced with decisions regarding the enforceability of existing contracts and should consult legal counsel if they are faced with their own inability to perform or the refusal of service providers to perform. The outcome of these disputes could have lasting impacts on profitability.

Looking Forward

After the immediate effects of COVID-19 pass, investors will seek returns in private companies due to the low interest rate environment. Companies should use this time to solidify relationships and provide investor updates on how they have pivoted their strategies to weather the storm. Companies with immediate capital needs should look to existing investors who understand their business and have skin in the game.

Management should avoid panic and maintain open lines of communication with employees, including conveying best practices for extended work from home conditions, informing of employees of increased cybersecurity risks that are likely to result from a decentralized work force, and ensuring employees have the resources and support needed to work remotely. These conditions also call for employers to provide flexibility to employees who are balancing health and family concerns during this time.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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