Challenges and Opportunities: COVID-19’s Impact on the Venture Capital Landscape
The seemingly overnight shift to working from home has put a few startups on the map, demonstrating in real-time how dependent we are on technology to function as a society. Who could have predicted a video conferencing solution would end up being worth more than all seven major airlines combined?
While startup founders and investors boast of increased productivity and seamless remote operations in our current environment, the future investment landscape has become decidedly less certain. Some insights can be drawn from the dot-com bubble and 2008 financial crisis, but the unprecedented circumstances of the pandemic and its economic impact have led to a few new noticeable trends:
A disrupted network effect. For an industry built on investing billions of dollars in startups promising to leverage technology to remove human capital, it may seem surprising that it’s heavily dependent upon in-person interactions. The mystique of Silicon Valley was built around famous deals taking place at coffee shops, in hotels and over lunch. Introductions are a form of currency, crucial to the fundraising process for both founders and investors. One only has to look to the PayPal Mafia to see the ripple effect of having the right network. But with travel currently out of the question, many are left scrambling to replicate in-person meetings with Zoom calls and phone interviews. Not coincidentally, Clubhouse, an invite-only beta networking app with just two employees, recently raised at a reported $100 million valuation.
Networking apps aside, the venture capital community is being forced to reevaluate their due diligence process. Investors now must ask themselves: “Am I willing to invest millions of dollars in a company whose founder I’ve never met in person?” Simultaneously, entrepreneurs must decide whether they’re comfortable accepting capital and working with an individual or firm they’ve never met face-to-face. Quite often, investor-founder relationships are compared to marriages, with good reason – these relationships can last for 5-7 years or more. While a startup has a .00006% chance of becoming a unicorn, all it takes is that one deal to alter a founder’s – and venture fund’s – future.
Without the ability to meet in person, preceding reputations and current networks will become even more critical for conducting deals. Investors and entrepreneurs will rely heavily on their networks to validate opportunities. Trusting your gut, network and Zoom connection will be critical to decision making over the next six months.
New market opportunities. Uber, Square, Venmo, WhatsApp, WeWork, Airbnb – these companies were all founded during or after the 2008 financial crisis, heavily shaped by the economic conditions at that time (Airbnb was created because the founders were struggling to pay their rent). While certain markets have seen an overnight shift in demand, it is crucial to identify which customer behavior trends will continue to remain once work-from-home restrictions have lifted.
Startups can leverage the current environment to move forward, however. Professor Sonia Marciano introduced the concept of variance – focusing on the piece of the supply chain with the greatest discrepancy (think Apple and Amazon targeting distribution and fulfillment). Startups who identify high-variance, high-weight opportunities during these current conditions will have the opportunity to grow exponentially faster than their competitors. Because no matter how hard you work, timing is everything.
An uphill road for female and underrepresented founders. In 2019, $114 billion of venture capital was poured into startups, but female founders received just 2.8% of that amount – sadly, an all-time high. The advice VCs are doling out to entrepreneurs during the pandemic (best articulated by Sequoia Capital in their Medium post Coronavirus: The Black Swan of 2020) – prioritize profitability over growth, extend your runway by six months and bootstrap for as long as possible – are the realities and expectations that have always been placed on female and underrepresented founders.
With VCs relying heavily on their existing networks, making new connections will be that much harder for first-time founders. Entrepreneurs need to be strategic in leveraging virtual conferences and their advisory networks to navigate funding. Ksenia Yudina, founder of U-Nest (a Northwestern Mutual Future Ventures portfolio company), was recently interviewed by Forbes about her fundraising journey as a female fintech founder. Ksenia says she was strategic in selecting advisors and structuring their equity to be directly tied to value-add, which resulted in more than 60 introductions. (At Northwestern Mutual Future Ventures, we remain committed to investing in female and underrepresented founders; if you’d like to connect with our team, please send us a message.)
Digital optionality over digital everything. With a captive audience and limited entertainment options that extend beyond a living room, many startups have seen an increase in user activity and conversion rates aided by a decline in advertising costs. This uptick in mobile-first choices, particularly in the fintech space, lead many to believe consumers will make these same decisions once we return to “normal” (whatever that may look like). Not unlike the varied generational responses to the pandemic, we predict consumers will expect digital optionality, not digital everything. Because sometimes, too much of something is not a good thing.
For many startups, the upcoming months – and years – will be challenging to navigate. Insights can be gleaned from historical trends and market observations, but without uncertainty, there is no growth. To quote Sun Tzu: “In the midst of chaos, there is also opportunity.” Founders who can embrace this will be rewarded accordingly.