Should we look to China for hints as to what will happen with global VC? For our startup community to survive, we need to observe ground zero and monitor the shockwaves hitting regions ahead of us. Since the COVID-19 pandemic hit, Chinese VC deals have taken a plunge and we’re left asking whether we’ll see similar trends hit the rest of the world.
While we may see a decline in startup investments, there will be plenty of opportunities for entrepreneurs who can meet the needs of a new market. With $33 billion of assets under management[i], VC and private equity, we explore how start-ups can be ready to raise funds when restrictions are lifted and we enter the ‘new normal’.
What lessons can we learn from China
The country did see a rebound in March, but VC funding remained below pre-crisis levels. Even before the outbreak, China suffered a slow start to 2020 with VC deals falling from 340 to 144 and the capital raised falling from $4.3 billion to $1.4 billion in the six weeks from 1 January 2020 to 19 February 2020.[ii]
What does this tell us?
- Waning confidence in domestic start-ups and poor post-IPO performance from several tech companies contributed to fall of funding activities.
- Those expected to be a huge stock market success i.e. Chinese electric vehicle maker Nio, were forced to raise outside capital. Nio isyet to trade above its IPO price in the last year.
- Similarly, Xiaomi, the Chinese smartphone maker which was expected to be the largest IPO, was listed below its estimated IPO price in July 2018 with its hare price declining significantly since being listed. Today Xiaomi is trading at 55% below its IPO price.
- Coming from a low base, it seems that deal making in China is continuing with 66 VC deals recorded in the last week of March 2020 alone.[iii] Overall, private capital transactions in China increased by a staggering 150% month-on-month in March.
While it’s still too early to draw any finite conclusions, China’s quick recovery might imply that the impact of the COVID-19 pandemic on VC markets can be contained.
Australian VC funds are cashed up and ready to invest
During 2019 Australian VC funds raised a total of $632 million to invest in Australia. This represents the second highest annual total in the past decade. Analysts cautiously anticipate an increase in activity once the immediate impact of the virus subsides.
The VC investment door is not closed given that:
- Australia recorded its second highest VC investment even with a significant drop in deal count in Q1 2020.
- Australian VC investment increased to $429 million with digital bank, Xinga, raising the largest amount ($160 million)
- Sydney Angels (investment group backing start-ups) just announced a total investment of $2.4 million across three start-ups: SAAS data startup Trendspec, insurance startup JRNY and virtual group booking platform Cogsworth. This sends a strong message to start-ups and founders with great ideas.
What we can learn from the VC cycle during past recessions:
- Past outbreaks including SARS in 2003 and the 2016 Zika virus, both weighed on public and private investment activity. During our ‘triage’ stage (where we are today), VCs will be slow to make any new investments while reviewing their current portfolio companies to determine which to continue to support.
- Investors will favor startups that keep burn rates low, are hyper-efficient and can demonstrate a level of growth even in slow market.
- During economic downturns, valuations and pricing require extra consideration with VCs focused on increased rigor around due diligence and post-investment execution.
What the global scene looks like:
- US has been largely unaffected in the first quarter of 2020. We expect a decline in total VC transaction volume over the remainder of 2020 and beyond.
- There is ample dry powder in the market. Globally, VCs had around $188.7 billion in dry powder as of mid-year 2019.[iv]
- Market turmoil will bring new opportunities for investors with deal terms back in their favour (compared to a prolonged trend of founder-friendly deal terms).
See the silver lining – this market could be good for you
Over the next few months they’ll be some unique opportunities to gain market share and raise capital. Some VCs will continue to invest steadily, and HNW individuals and private markets will be looking beyond the stock and debt markets for ROI. With VCs holding record amounts of ‘dry powder’, they’ll be looking at innovative startups with sizable future revenue streams and limited risk. Knowing how you can attract VC investment could make the difference between survival and collapse.
What are VC funds looking for?
- Focused & Actioned: Founders that take action rather than waiting out the ‘storm’.
- Flexibility: Startups that can show an ability to adapt to a changing environment, swiftly
- Profitability: More emphasis on startup profitability over and above growth.
- Scalable: Those that can show a reduction in risk with market validation and can demonstrate that their revenue stream is scalable with market traction.
- Market Pivot: Companies with a deep understanding of the unit economics, profitability and strategies for potential market pivots.
- Deal Protection: Investors will move slow and be much more cautious, looking for protection and liquidation preferences that will impact deal terms.
How can you increase your future revenue?
- Don’t be limited to one market. See if your product can be used in different sectors, countries or even an emerging market.
- Reassess your business model and see where you can capture a bigger margin. Is there hidden value in any of the supply of distribution chains?
- Explore high value markets and industries that could boost size of your revenue stream. Where can your product or service be used that has high margins?
A recent survey of VC investors[v] also shows that companies with thorough plans for surviving a downturn, or those that have already successfully navigated through a crisis, will be at an advantage.
Emerging trends – sectors to watch
Consumer investment in digital fitness has increased by 30-35% relative to pre-crisis levels, positioning the sector for faster growth in the future. Digital health services existed prior to COVID-19 and were already poised for solid growth but demand has surged since this crisis.
It’s expected that digital fitness and mental health will continue to be highly valued and attract investors. Given the ongoing shift towards an increasingly mobile lifestyle, these sectors are expected to continue to rise even after gyms and wellbeing centres re-open.
Businesses in ‘solid’ sectors such as education, banking and hospitality are being forced to rapidly change their business models to adapt to economic uncertainties and changing restrictions. Meanwhile, new businesses in seemingly marginal sectors such as telehealth, edtech and agritech are developing new solutions and thriving. There are a number of sectors to watch – click here to view.
Insights and tips from our Experts
[i] Preqin & Australia Investment Council (AIC) Yearbook 2020
[ii] PitchBook article dated 19 February 2020
[iii] PitchBook article dated 5 April 2020
[iv] PitchBook analyst note on COVID-19’s Influence on the US VC Market
[v] S&P Global Market Intelligence
[vi] S&P Global Market Intelligence
L.E.K Insights: https://www.lek.com/insights/covid-19-accelerating-digital-fitness-boom
