Some of the posts to this progressively-built article no longer apply, and that’s a good thing because it means investor and fundraising dynamics have returned to normal.
I never imagined I would write an article with this title “Fundraising During a Pandemic”. But, starting March 15, 2020, I began posting various insights and advice to startup founders that were attempting to fundraise as the coronavirus (COVID-19) outbreak started spreading throughout the United States and progressively caused massive disruption to business and personal activities of all types. As the days and weeks went on, I gained additional insights that I shared in subsequent posts. Those posts are chronologically listed in the article below.
I hope this is helpful in some small way.
Posts on this Page:
- March 15, 2020 – Original Post
- March 18, 2020 – Investor Sentiment
- March 20, 2020 – Catching Investors’ Attention
- March 25, 2020 – The Color of Your Revenue Forecast
- April 4, 2020 – A Bridge Round Could be a Big Waste of Energy
- April 8, 2020 – Venture Debt Covenants & Collateral
- April 12, 2020 – Investor Meetings in a Virtual World
- May 13, 2020 – Investor Priorities Based on Current vs Future Normal
- June 30, 2020 – Investors Start Loosening Up
March 15, 2020 (original post)
The immediate impact to startups will be a slowdown and delay in funding activity while investors of most types try to decide for themselves how much worse things will get and how long the situation might last. The slowdown will also occur simply due to the increased difficulty of travel and recommended social distancing. Videoconferencing only goes so far when it comes to investor interactions.
Angel investors and family offices will be much more conservative as they deal with the value of their personal investment portfolio dropping quite a bit. However, after venture fund managers have a month or two to figure out how bad things might get, I’m of the belief they will continue to invest at a similar pace as before the crisis. That’s because a fund manager for a traditional 10-yr fund needs to deploy their LP’s capital within the first ~3 years of the fund to optimize their IRR and other key fund performance metrics. They can’t just sit on the sidelines for a year. The question is whether they’ll prioritize the use of their capital to help companies they invested in from their prior fund(s), thereby protecting their portfolio and potentially investing at a good valuation for the benefit of the LP’s in their current fund.
My opinion on venture funds would change quite a bit if the economy and stock market get so whacked that it causes fund LP’s to decommit on their capital calls, like happened in the years following the Great Recession. I’m also nervous about venture funds that have completed their initial close and started making investments, but haven’t yet reached their final close. Those funds will need to recalibrate their investing amounts and frequency.
The longer this “new normal” continues, the more the balance of negotiating power will increasingly swing to the investors’ favor. This translates to more aggressive and investor-friendly terms (we might start seeing 1.5-2.0X liquidation preferences and the like) and lower valuations. But I believe Silicon Valley valuations will take a far bigger hit than the middle of the country, where startups don’t typically experience wide ranges of increasing and decreasing valuation. Instead, their valuations tend to remain pretty steady throughout.
March 18, 2020 (Investor Sentiment)
I’ve spoken with lots of founders over recent days. They are all seeking some way to conceptualize investor sentiment and activity levels over time as the outbreak and its impact to society runs its course. Below is a 3-phased visual to better understand my early assessment. Unfortunately, it is too early to assign time frames to each phase and that’s the biggest contributor to investor paralysis. I’m also sure there will be exceptions to my assessment.
Realize that we might move to Phase III but then have a second (or third) wave of the outbreak that is significant enough to move us back to Phase II from an investor sentiment perspective. The same thing could happen if the virus mutates enough to put potential vaccine viability into serious question or doubt.
March 20, 2020 (Catching Investors’ Attention)
How do you catch an investor’s attention at a time like this? Well, as I posted before, I’m of the belief that pretty much all venture-style capital from angels and VC’s will be on hold at least until there is some visibility to when the peak of the outbreak will be reached. So, I’ll answer the question by assuming we are in the phase after that and mostly in relation to institutional investors rather than angels.
Startups that have a year of runway won’t desperately be fundraising. But startups with less than 90 days of runway are going to have an unbelievably difficult time because of the added risk the investor would be taking on. It’s true that the desired funding will mostly be used to extend the runway, but at times like this investors will want to make sure a sufficient amount of capital is fully committed before they actually write their check. That probably means they’ll want you to secure 18+ months of runway. That also means seed rounds and bridge rounds with rolling closes and convertible securities will inherit the “initial close” concept from equity funding rounds, whether it’s written into the docs that way or not.
Side Note: Read my article titled “A Startup’s Most Valuable Resource” to gain insights about optimizing for time/runway
Maintaining flat revenue during a crisis like this should be impressive to investors. The saying “flat is the new up” will become common. And if other fundamental KPIs are holding together, I could imagine some scenarios in which moderate revenue declines seem OK to investors.
Maintaining churn rates in the range of 10-12% on an annualized basis (not monthly) will seem extremely impressive and 18-20% might even be acceptable. But a lot of this depends on the rate of new customer acquisition to offset the churn.
Side Note: Read my article titled “Visualizing the Interactions Between CAC, Churn and LTV” to better understand the broad impact of churn.
Investors’ assessment on this front will vary greatly based on the type of customer you sell to. Those that sell to the government and military are probably feeling pretty good right now, especially those that are under a multi-year contract of some sort. Those that sell to consumers are more likely to be in big trouble. That leaves those that sell to commercial businesses of all sizes. If your solution doesn’t save them money or make them money almost immediately, you’re in trouble because, for some number of months at least, businesses won’t spend even $1 if it doesn’t accomplish one or both of those things.
Variability of Spend
Investors will enjoy it if you have some remaining variability in your expense budget. They will be concerned if you’ve already significantly cut your staff and other growth-related expenses and the only remaining lever you have is to cut more staff. That’s what is referred to as the “death spiral”.
At a time like this, why shouldn’t investors just wait a while longer? If you have other potential lead investors or some other reason for the investor to make a decision sooner versus later, you’re very fortunate. Be prepared for investors to give you more homework assignments after each meeting rather than telling you “no”. Why should they make a decision they don’t have to make?
March 25, 2020 (The Color of Your Revenue Forecast)
Investors will drill harder than ever into your revenue forecast. I’m not just talking about the numbers you present, because that’s obvious. I’m also talking about your possible sources of revenue and the viability of the methods used to generate it. I’ll break this into three segments:
You’ve heard the saying “a dollar saved is a dollar earned” and this definitely applies to a time like this. A dollar churned requires a dollar newly-generated to offset. What can you do to preserve any existing revenue you have? This assumes you have a recurring revenue model of some sort.
New Revenue from Existing Customers (farming)
These customers already know the benefits of your offering and they trust you. Can you sell them more of the product they’ve already bought (upsell) or sell them additional offerings on your menu (cross-sell)?
New Revenue from New Customers (hunting)
This is the hardest of all. The prospects don’t know you and you have to go through the full sales cycle with them. And if you use a field sales model rather than inside sales or self-service, it’s going to be infinitely more difficult while the world is on high levels of alert (travel restrictions, employees working from home, etc).
Don’t just think about this when you present your forecast to investors. Assuming you’ve been able to maintain low churn (preservation) and have a viable strategy for maintaining that, make sure to proactively mention it. If you have a history of upselling and cross-selling to your installed base of customers and have a viable strategy for maintaining that, make sure to proactively mention it.
April 4, 2020 (A Bridge Round Could be a Big Waste of Energy)
I’ve talked to a lot of startups that quickly realized they wouldn’t be able to raise enough funding to gain more than a year of runway to hopefully weather the storm. So, instead, they did what seemed like a logical alternative – raise a bridge round to gain any additional runway possible.
There are multiple potential flaws with this strategy. First, no new investor is going to invest in a round that only gains the company a couple/few months of runway. Even 9 months of runway probably won’t make them comfortable due to the various uncertainties mentioned in my second post above (March 18). Second, in normal times it take months to identify, pitch and secure investments from new investors. In these times, it will take even longer and have a much, much lower batting average of success.
The net result of the before-mentioned flaws is a bunch of energy put into fundraising that could have been focused on doing things to minimize revenue churn, generating revenue via creative ways, finding side jobs for bootstrap-style income, generally reducing expenses across the board, negotiating with those you owe money to, and applying for government assistance. Raising bridge funding involves a lot of energy with low odds of success. Focusing on the other mentioned things also involves a lot of energy but with higher odds of success. Both extend your runway, so why not focus on things that have higher odds of success?
For the most part, only friends & family and existing investors will consider funding a bridge round at times like this. A few phone calls and emails can quickly determine what you can round up in funding from them. Minimal energy involved.
Side Note: Read my article titled “Bridging a Gap Using a Convertible Note” to learn some of the nuanced terms that are standard for this situation.
April 8, 2020 (Venture Debt Covenants & Collateral)
Outside of various government-backed assistance programs, many startups will pursue various forms of debt. This post covers some important requirements that might be associated with that debt.
When you apply for a home mortgage or car loan, you have to provide information to demonstrate your credit worthiness. A mathematical algorithm, and possibly some human judgment by a loan officer, determines whether you get the loan. After your purchase, you simply make your monthly payments until the debt is repaid. If, for some reason, you aren’t able to make the payments, the bank gets ownership of your home or car and your credit score take a big whack.
Startups that try to raise money at a time like this are learning the similarities and differences between venture debt and traditional debt like was mentioned above. Much of that lies in what is referred to as covenants and collateral.
The lending institution obviously needs to protect themselves in various ways. Covenants are one way to do that. They are basically a set of financial and/or non-financial requirements that, if breached, could be cause for default.
Financial covenants can include things like revenue targets and minimum cash balances. Non-financial covenants often require the lender to be involved in decisions like selling the company or licensing intellectual property.
It is important to pay very close attention to any covenants that govern your new debt.
If you default on your home mortgage or car loan, the lender takes ownership of the asset. That’s because you had to pledge the asset as what is referred to as collateral. In the case of venture style debt, there often aren’t assets that have such defined value as a house or car. As a result, don’t be surprised if your lender wants the founder(s) to be personally liable if there is a default. It’s called a “personal guarantee” (PG). Yikes!
It is extremely difficult for me to suggest that you consider granting a PG, unless you are a high net worth individual that can afford the risk.
April 12, 2020 (Investor Meetings in a Virtual World)
Whether investors are actively writing checks or not, meetings between founders and investors should, and will, continue. But what does a successful investor meeting look like in a virtual world and what can a founder do to ensure the best meeting possible? That’s the topic of this post.
It’s Not a Pitch
As you use a variety of methods to secure the meeting, don’t come across as if you want to pitch the investor for investment. Of course, that’s your objective, either now or in the near future. But now isn’t the time to be a hard-closing sales person. Instead, be a relationship builder. The purpose of the meeting is to get to know each other and for the investor to determine if what you’re working on could be of investment interest in the future, once they are actively writing checks again.
Number of Founders
Many in-person meetings with investors involve two co-founders that tag team the presentation and discussion. But in a virtual world, that adds complexity that should be considered. The lack of body language clues and the delayed audio stream from the videoconference dramatically increase the odds that the founders will trip over each other during interactions.
Just like with an in-person meeting, the overall quality of the interaction will influence the investor’s perception of the company and the opportunity. Having a single founder (likely the CEO) take the first meeting solo is probably the least risky, in this regard. But, if there are reasons to have multiple founders participate, closely coordinate who is going to present certain topics, and the same for handling questions. Videoconferences are not conducive for regularly “chiming in” with seemingly helpful additional information. And whoever isn’t talking needs to remain focused on the meeting (looking into the screen), not texting on their phone, working on emails, or writing code. You wouldn’t do those things if you were sitting at a table with the investor.
Audio & Video Quality
If your audio or video stream get glitchy, it will greatly impact the overall quality of the interaction. If you subscribe for the most basic data package with your Internet provider, upgrade it. You can probably double your bandwidth for an extra $20/mo. If you have a crappy webcam or headset, replace it.
If you have a home office, great. If not, your couch or outdoor porch are not good settings. Situate yourself with the camera as level with your face as possible (ie – not on your lap looking up at your face) and think about what’s behind you. A blank wall or a wall with a piece of artwork is great. A collage of party photos from your college days isn’t, and a window behind you turns you into a silhouette. Finally, try to pick a location where background noise is minimized.
Dress like you would if you were meeting the investor at their office, or possibly one minor step more formal than that. And go through your normal morning grooming routine, as if you were going to meet them in their office. Look like Tuesday morning much more than Saturday morning after a hard night of partying.
Presenting and Demonstrating
In the event that you’ll have a chance to present some of your pitch deck or do a short product demo, prepare and practice ahead of time with a co-founder. Know exactly where the share buttons and related collaboration functions are for your chosen videoconferencing service. And in case the investor wants to use their favorite service, do a practice with it ahead of time. If you fumble basic presentation and collaboration tasks, it will have a negative effect on the overall quality of the interaction.
At all costs, DO NOT read from a script during your presentation. It is OK to have some cheat notes to help remember important factoids and things like that. But reading from a script will be obvious, take your visual focus away from the camera, and generally not be natural or exciting.
Call to Action
Just like in-person meetings with investors, you always want to finish with a request of some sort. If the environment still isn’t suitable to review the parameters of your funding round and ask about interest, instead simply ask if you can put them on your list to get regular updates (then make sure you do that like clockwork). Also ask if you can have a follow-up call after you’ve achieved something you told them you would accomplish in the next 30-60 days. Foretelling what you’re going to accomplish and actually achieving that is always impressive to investors, but especially at a time like this.
May 13, 2020 (Investor Priorities Based on Current vs Future Normal)
I’ve had multiple venture fund partners tell me some version of “we’re currently only serious about super-hot opportunities”. But what does that mean? We know there are certain startups that have been dramatically advantaged by the current pandemic. They’re posting impressive revenue growth, are possibly struggling to keep up with demand, and have a year or more of runway (even without sustained crazy levels of growth). But will they also be advantaged after things eventually evolve into a future new normal? Some will and some won’t. That basic framework provides some guideposts for how many investors are prioritizing their investment opportunities, whether they realize it or not.
While we’re in phase 1 or phase 2 of the pandemic as described in the first post to this page, investors will mostly only consider investment opportunities represented by #1 and #2 in the graphic below. It makes sense because those opportunities exist and any other investment opportunity is considerably more risky at the moment. As we move to phase 3, investors should start considering opportunities represented as #3 and #4.
I recommend that you honestly evaluate where you fit on this priority list and consider including specific messaging about your likely business success when things evolve into a future new normal. The current impact to your business will be obvious via your recent results.
I didn’t add all of the combinations to the table, such as Neutral -> Disadvantaged or Disadvantaged -> Disadvantaged because they all rank below the top 4 scenarios and I don’t believe they will be considered by investors, even in good times. And I don’t really see Neutral -> Advantaged or Disadvantaged -> Advantaged as viable scenarios (I could easily be wrong).
It’s mostly obvious that many startups fit into rank #4. And I’m seeing lots of them doing creative and desperate things to move from #4 to #3. If you can hold your revenue flat or slightly better, you might be able to situate yourself into #3, assuming that trend can hold for enough time to prove it’s not a fluke or short-lived phenomenon.
June 30, 2020 (Investors Start Loosening Up)
I don’t know if this will be the last time I need to contribute to this page, but I sure hope so. It would mean that things continue to improve from here.
Over the last 30 days or so I’ve seen an increasing number of startups get term sheets from seed and Series A venture funds. I’ve also talked to more startups that were successful getting angels to invest in their pre-seed or seed round. That is good news and noticeably different than what I witnessed in the late March through late May time frame.
While I’m communicating a level of loosening and the optimism that might generate, I have to also be clear that we are nowhere close to “normal” in terms of investor sentiment or activity level. They are still much more cautious and calculated than before the pandemic. They also continue to have a strong imbalance of negotiating leverage, which translates to lower valuations and more investor-friendly terms than before. But at least there are checks getting written, and I wanted to communicate that.
Venture funds are trying to figure out the changes needed to their process in order to do fully-remote deals (no in-person meeting). VentureBeat surveyed 150 VC’s on this exact topic. The most common process changes they uncovered are as follows:
- More reference calls than usual
- Preference for founders and teams they’ve previously met in-person
- More time on due diligence than usual
- Preference for markets they know
- Friendly VC’s already on the cap table
- Higher bar on traction and KPIs