2020: Year of the Unicorpse, or a Black Swan with a Silver Lining?
“Question every assumption about your business” was the message to CEO’s and Founders from leading Silicon Valley VC, Sequoia Capital in their March memo, “Coronavirus: The Black Swan of 2020”.
Referencing Darwin’s ‘Survival of the Fittest’ theory, Sequoia asserted that company survival would boil down to “fast and decisive adjustments to changing circumstances.”
Fast forward a couple of months, and the world is in lockdown, or on a “Circuit Breaker” as Singapore prefers to label it. But, more than circuits are breaking. From multi-billion-dollar enterprises to bootstrapped startups, companies are battling to stay afloat from the ongoing impact of the economic iceberg- COVID-19.
Travel and Hospitality sectors were the most visible early losers; revenues vaporized overnight by global travel restrictions. But, the same measures critical to saving lives can’t help but also intensify the economic undercurrents threatening to pull under companies far more indiscriminately.
In “flattening the curve” of infection, we are steepening the curve of recession.
The repercussions for Startup ventures are already evident in Venture Capital deal numbers.
VC’s be like: “Let’s Talk Later”
Early-stage founders are facing a funding drought. Whilst many VC’s give the outward impression it’s very much business as usual, albeit by Zoom or Hangouts. Analysis of Q1 venture deals in China, across all funding stages, reveals a drop of 60% in Q1 2020 compared to Q1 2019 and at Seed stage a staggering decline of 86%, year on year.
“To put this into perspective, this is three times the size of the decrease during the global financial crisis of 2007–09. Some estimate that if a drop like this were to happen globally, approximately US$28 billion in startup funding could be lost.”
For all it’s focus on technology and better ways of doing things, Venture Capital is still mainly anchored on face-to-face deal-making. Travel restrictions prohibited this in China in most of Q1. But it’s also true that an industry whose mandate is to anticipate and shape the future of commerce was just as blindsided by the pandemic.
VC’s rushing to the scene have carried out triage on portfolio companies and are re-evaluating deals with a “what does this mean for Industry X, post-pandemic” investment lens.
All the while startups are bleeding cash, and that’s leading to…
Valuations: Startup Discount Bonanza!
Investors are still writing cheques, more so for later-stage investments as they try to ensure their ongoing commercial viability- but I’ll come to that shortly.
Coronavirus is slowing the pace of investment and early-stage startups are making do with less, bootstrapping, entering hibernation mode, furloughing or letting go of employees, conserving cash, and still possibly facing extinction.
Let’s not forget, under reasonably buoyant conditions, the odds are already hugely stacked against them.
Analysis from Dealroom shows at best, only 20–30% of seed-funded companies go on to raise Series-A. Thereafter, the follow-on funding rate is about 50% for each stage
The laws of supply and demand dictate that as investors part with cheques less often and assess companies through the lens of a global recession, investment terms and valuations will inevitably become more investor-friendly. How much?
Time will tell but, Matt Clifford, CEO of Entrepreneur first recently shared his best guess in an interview with Protocol:
“most seed funds intend to cut their pace by about 50%, so half the number of investments in 2020 that they would normally do. And because of that, supply and demand just means that capital valuations will fall. I expect valuations to fall 30% to 40%, even in seed, and at least that farther up the chain.
If seed startups can expect a 30–40% haircut compared to 2019 valuations, what does it mean for the burgeoning stables of late-stage prestigious Unicorns startups prancing among us?
Behold! A Flock of Flying Donkeys…
A pretty paddock of high-profile startup founders may soon come to regret their Unicorn status.
The Capital-injected euphoria was already starting to ebb by late last year. Starting with Softbank Vision Fund-backed Uber’s valuation crash in April. Chasing a $100 billion stock market debut valuation, experts pegged its actual value at about $60 billion.
Then came the SoftBank-WeWork IPO soap opera. The co-working giant was valued at $47 billion but before going public, its actual valuation was found to be closer to $14 billion — 70% down from its private market valuation. Softbank then pulled the plug on the WeWork IPO and the ensuing divorce has WeWork suing their investors over backing out of a $3 billion funding deal. What seemed like a dream combination of endless resources and ambition, was, in reality, a case of too much, too soon.
SoftBank is the World’s Biggest technology investor with a 100 Billion fund and an approach that appears to involve throwing mountains of cash at Unicorns with a top-line “Growth at all Costs” mantra.
Full -Disclosure I have yet to invest in a company with a valuation of $1b, so you can label me as jealous if you like, but I loath the word “Unicorn” and everything it has come to represent.
Entrepreneurs throw the word around like chump, baiting their hooks for Investor sharks — “The next Unicorn”, is a frequent opener in my Linkedin inbox. But, can you blame them, when it’s all that the industry media seems to go on about?
But here’s the thing- it’s precisely the wrong thing to focus on:
a) Valuations count for very little until a liquidity event or exit. Tech IPO’s are far rarer than billion-dollar startup valuations.
b) Higher-valuations are frequently packaged up in conditions- liquidity prefs, anti-dilutions and stricter governance, that are detrimental to the founding team’s ultimate financial outcome. A more modest valuation with less dilution could be a better indication of success.
c) Today, more than any time in history, having a billion-dollar valuation has little correlation to the health of a business.
Unicorn’s can be thoroughbred’s- highly-profitable, world-beaters, or inbred’s- cash-hungry, overweight, pregnant with investors and ultimately lame.
A Stanford University study of US companies from January 2020 found that on average, unicorns are priced 48% above their fair value. Each of the 135 US-based unicorns that were studied were found to have value inflation, ranging from 5% to 188%. Not the best bill of health coming into an economic crisis.
The Reckoning
On Thursday (April 30th), SoftBank announced an additional $6.6bn of losses in WeWork. This came only two weeks after it reported $16.7 Billion of losses on it’s Tech Fund.
The numbers are almost beyond comprehension. These aren’t industry losses, just one portfolio of VC investments, albeit a massive outlier.
A pre-Coronavirus (Oct ’19) Rosenblatt Securities survey of investors said they expected the 58 FinTech Unicorns globally to be most impacted, in the event of a recession, with average valuation contracting by about 15%. With $510B of market capitalization at the time, that implies, a protracted downturn could wipe off $76 billion of Unicorn market value.
The Coronavirus crisis has already led to Asia’s largest investors offering stakes in unicorns like Gojek (Indonesia’s most valuable startup, offering a variety of services like taxis, food delivery and banking) and Didi Chuxing (China’s largest privately-owned transport service) in the secondary market. The secondary investment market is expected to boom in Asia, as many investors lack exposure in handling investments during a serious downturn. Gojek raised over a billion dollars in March, whilst simultaneously letting go of approx 100 staff, and that’s a company with a relatively strong value proposition during a pandemic lockdown.
Where do we go from here?
For the past decade crazy sums of money, from sovereign-wealth funds, mutual funds and hedge funds have poured, directly or via VC’s into startups that were unicorns or, their investors believed might soon be one. But the music just stopped.
Pockets of Venture Capitalists and Investment Bankers have approached investing in Tech as if they are playing a high-stakes game of Capture the Flag. A period of austerity (and hopefully, correction) was a long time coming for the ecosystem.
Has the winner-take-all approach of tech investors, combined with excessive fundraising and cash burn rates changed the VC industry? Unmistakably. Has the industry overlooked the value of frugality and profitability for topline growth vanity metrics? Undeniably. Have VC’s prioritizing unicorn potential over sustainability and pragmaticism? Unquestionably.
Some Unicorns will die, others will have their $1b valuation horn clipped, but not to the same fanfare as they were bestowed. For the most part, it will be silent, behind boardroom doors. Saving face.
The pandemic-induced disruption in regular business and society gives us a unique opportunity to retrospect and introspect. To take a time-out and evaluate if we’re okay with the trajectory of our industry. At VenturesOne, we’re not. We’re investing in emerging technology businesses the only way we know is sustainable: coming on board as a patient investor and partnering up for the long-term.
The Silver Lining in this Black Swan is that Covid-19 is driving digitization like no other event since the dot-com boom. In driving this much-needed transition of services across healthcare, education and beyond, we will see fitter, more resilient and ultimately better services delivered in the recovery.
And while the immediate outlook is bad — The International Monetary Fund has advised that “the global economy is projected to contract sharply by –3 percent in 2020, much worse than during the 2008–09 financial crisis”. They also forecast that it will bounce back far quicker than the GFC — with growth of 5.8 percent in 2021 as economic activity normalizes.
Founders can take solace in the fact that Uber, Slack, Square, WhatsApp, and Instagram were created coming out of the last recession. There will be many more innovative companies that will come out of this pandemic, and all the stronger for it.
