Coronavirus: VC funding may have paused, but market is seeing new ‘hot’ sectors and investing models
On March 6, 2020, Silicon Valley’s most prominent VC firm Sequoia Capital sent shivers down the entrepreneurial world in a note to its portfolio companies.
Sequoia termed the coronavirus pandemic “the black swan of 2020”, one that would have far-reaching implications — as dire as those witnessed during the global economic crisis of 2008-09.
Two months on, the full-fledged ramifications of the pandemic on VC investing and startup funding are starting to unravel. “These are challenging times. We are facing a crisis of both life and livelihood,” says Atul Nishar, President of TiE Mumbai.
TiE Mumbai recently held a webinar with founders, VCs, angel investors, and advisers from across the globe to help startups tide through this testing period.
Illustration: Aditya Ranade
‘Testing’ because after a record-shattering Q4’ 2019, VC investments in Asia are headed for a 12-quarter low, according to KPMG’s Venture Pulse study.
Funding fell to just $2.2 billion in Q1’20, from a record high of $6 billion in Q4’19, mostly due to economic uncertainty around COVID-19. The average deal value stood at $140 million in the quarter.
“Q1’20 was unlike any quarter on record. The emergence of the novel coronavirus shattered original expectations for the year,” states the study.
What played out in Q1’20
Initially, India was not as affected by COVID-19 as compared to China. The effects started playing out March onward, with investments pausing, deals getting deferred, and term sheets being withdrawn.
Despite these challenges, India saw several good-sized deals in Q1'20.
Edtech was a big winner in Q1'20 withraising $400 million (from General Atlantic and Tiger Global), Unacademy raising $110 million (from Facebook and General Atlantic), and Aakash Educational acquiring Delhi-based startup for Rs 1,350 crore.
BYJU’s funding was also the sixth-largest VC deal in Asia in Q1’20, KPMG reveals.
The other big gainer from India was mobility startup, which raised $150 million from existing investors Eduardo Saverin’s B Capital and Accel Partners India.
Edtech was the big winner in India in Q1'20
However, concerns related to the pandemic are growing louder now. It is mostly driven by the fact that India receives a significant amount of VC investment from international firms and corporate venture arms, with a lion’s share coming from China.
But as COVID-19 spread through the region, the number of VC deals plummeted as investors hit the pause button.
Bhaskar Majumdar, Managing Partner, Unicorn India Ventures, tells YourStory,
“We have had individual discussions with our entrepreneurs and have asked them to not roll out any new products, cut all non-essential costs, bring down cost of operations, and freeze any business expenditure. We have also assured them that as they work hard to increase their runway by 15 to 20 months, we will be open to infusing some funds should they need it. Clearly, our priority is to help our current companies, so new investments will take longer to close.”
Add to that, the global stock market uncertainty has also taken a toll.
“The primary source of funds for investors is the stock market. When that goes down, it has a spillover effect on investments into unlisted entities,” Siddarth Pai, Founding Partner oftold YourStory in a prior interaction.
Projection for next few quarters
Even though deal flow is likely to slow down significantly in Q2’20 — in some sectors, it could even be a complete washout this year— the deal pipeline is expected to remain “relatively robust” in India.
Nitish Poddar, Partner and National Leader - Private Equity, KPMG in India says,
“VC investors are already starting to ask the question, ‘How will your business be impacted by COVID-19?’ This is a question everyone will be asking for the next few quarters. Over the next quarter, while the pipeline will likely remain strong, deal flow is expected to slow down. A lot of deals will probably get deferred to the latter half of the year.”
Early-stage deals (angel/seed/Series A) have been the worst hit so far, and are likely to get tougher. “The bar for Series A investments will definitely go up, and a lot of focus will be on unit economics rather than ideas of wild scale,” says Sanjay Swamy, Managing Partner, Prime Venture Partners.
Series D+ rounds are likely to be the least impacted, with VCs preferring to back already established business models. “Deals that do occur will likely involve follow-on funding to companies within the existing portfolios of VC investors,” says KPMG.
The general sentiment, however, remains bleak.
Innoven Capital states in its recent Startup Outlook Report 2020 that founders are expecting a weak venture funding environment. It says,
“While 75 percent of founders had a favourable funding experience in 2019, almost 58 percent of them expect fundraising to be more challenging in 2020.”
Heading into Q2’20, even valuations are expected to nosedive. “Valuations will be more rational, particularly, in the consumer internet space,” says Bhaskar.
B2C startups are likely to be hit due to a fall in consumption
Owing to a dramatic fall in consumption, user acquisitions will slow down too. This will naturally hit the liquidity of startups as demand and cashflows drop.
Consumer internet startups are expected to take the maximum hit as their cash infusion requirements to acquire users are big-ticket. “Entrepreneurs will have to learn the lesson of managing their cash flow better and follow the mantra of cash is king,” Bhaskar adds.
While there continues to be an enormous amount of dry powder in the global VC market (more on that later), investors will likely sit on the fence until the ramifications of the pandemic become clearer, analysts believe.
“There could also be an increase in distressed investments in some regions as companies begin to run out of cash,” they say.
New investing trends and ‘hot’ sectors
The demand for digital business models has intensified. This crisis-driven action and quick innovations are making companies realise the value of digital on an “almost unheard-of scale”, say analysts.
Unicorn’s Bhaskar says,
“More M&As will pave the way for secondary exits. Lots of traditional businesses will acquire digital-only businesses to complement their offerings in the post COVID-19 world.”
Consumers too are seeing the value of ecommerce, edtech, digital entertainment and gaming, e-learning, virtual meeting, and other such services given their limited movement during the lockdown.
KPMG explains, “Consumers are being forced to embrace new behaviours. These changing behaviours could have significant staying power over the longer term, and could drive stronger investments in these spaces and more sustainable business models. Those who do not move very well may not be able to survive.”
Sectors that will be hugely attractive to investors due to their applicability in the current environment are health, biotech, pharmaceuticals, and life sciences.
Another sector likely to become a “hot area” is AI and data science. It could see quick momentum given its utility in COVID-19 tracking and monitoring. Due to lockdown extensions, even sectors like edtech, e-learning, productivity solutions, logistics and delivery, gaming and online entertainment are seeing an uptick, especially in India.
Cybersecurity and data protection companies too are likely to gain riding on the significant increase in online services, according to KPMG.
Bhaskar adds, “From an investment POV, in the long-term, we would be more interested in investing in businesses that are digitising the current physical business processes… and addressing a market opportunity where real problems exist whether it is simplifying logistics for pharma or bringing neo banking for SMEs.”
Rise in benevolent investments
There is an upsurge in benevolent and philanthropic investments in startups and services focussed on addressing COVID-19 challenges.
Investor interest is growing in companies that have been agile and nimble-footed in building new value propositions for customers. There is also an increased collaboration between VCs, banks, and other agencies to drive capital into COVID-19-related problem-solving activities.
Jonathan Lavender, Global Head, KPMG Private Enterprise, says,
“While VC activity is slowing down, we are seeing a strong increase in philanthropic investment in all regions of the world as investors, corporates, governments, and not-for-profits work to support innovative companies working on potential vaccines and treatments — or to help better understand and stop the spread of the virus.”
In India, Bexley Advisors, a boutique investment bank, issued a call for entries to its COVID-19 Action Fund. It is designed as a bridge to capital for innovators creating solutions for the biggest challenge facing mankind in almost a century. Bexley has also waived off its standard fees for it.
Utkarsh Sinha, Managing Director of Bexley Advisors, shares, “Investment banks are facilitators of the flow of capital at their core. It is imperative that we deploy our skills at a time like this, where without stimulus, natural funding channels may freeze. Just when the need for innovation — and capital — is the highest, we want to make sure we arrest any potential clog in funding flows and connect worthy ideas to capital to impact lives on the ground.”
It is no doubt that COVID-19 has been an enormous and unprecedented crisis. Hence, solutions to fix the impact of such an event will also be new and unforeseen.
Even though the storm is hardly over, the fact that global VC investors are sitting on nearly $189 billion (PitchBook data) of dry powder is giving the entrepreneurial ecosystem some hope. VCs may hold back their investments for some time, but they do not have the luxury to sit on the fence forever as that would impact their timelines and returns on ongoing funds as well.
“A lot of money is waiting to be deployed and invested,” affirms KPMG. “When the uncertainty around COVID-19 begins to decrease, VC investors will be looking for ways to deploy these funds.”