News & Insight

Venture capital March 17, 2020
Hard truths for early stage tech companies

Hard truths for early stage tech companies

This is a time of challenge most of us will not have faced before in the UK.  Management teams will be thinking ahead and planning.  And many will not be sleeping much.  Cash is king.

How will this pan out for European venture tech?  Clearly, nobody quite knows.  But here is one possible narrative.

Bad companies will go off the edge of the cliff so fast that there will be no sign of skid marks.

Good companies will still have access to funding… so long as they don’t run out of cash first.  Dry powder still sits there in its various forms on fund balance sheets across Europe.

But funds take time to deploy.  Months usually. And VCs have time on their hands, years in fact.

Events on the ground are changing on a daily basis.  Demand in various parts of the economy has been guillotined almost over night.  Many founder teams will be working from hour to hour right now.

Fund managers will be looking at pipeline and thinking about hitting the “pause” button to focuss on the existing portfolio.

Some fund managers may be in the difficult position of deciding which portfolio companies to allow to live with follow-ons as bridges to the next round.  And some which they cannot help.

And the thing about bridge rounds is that they have to be a bridge to something.

As with every crisis, having a fundamentally sound business model is helpful in terms of survival.  Some businesses will effectively mothball themselves for a few weeks if not months, laying off and cutting back anybody or anything not crucial to life support.  Some may never re-emerge, or may re-emerge in a different form.

So how’s that runway?  Founder teams looking at 12 months’ runway are well positioned.  They may even be positioned to take advantage of what will be a new-world in many respects post-coronavirus or at least this round of it.

Founder teams with a shorter runway will be thinking about the next round or a bridge to the next round.  And about the cliff beyond.

But the balance of power between founders and investors – for a long while tipped well towards the founders so long as the supply of capital increased – has just tilted, radically.

There will be fewer “fear of missing out” deals, with investors no longer flocking together to drive sky-high valuations on founder friendly terms.

Logically, valuations should come down – which may mean that the next round or the bridge need to be a down round.

And down rounds are rarely pleasant experiences and existing investors on the cap table usually have a lot to say about them.

Due diligence from investors will come into its own again – expect it to take longer and to be more demanding on management time.

Into the longer term, VCs and investors will have regained the whip hand.  Expect to see 1x+ liquidation preferences and equity ratchets coming back into term sheets.

Tech will survive of course – post-crisis there will be a renewed focus on research that many of us will not previously have seen in our lifetimes.

And the gentle slide in recent years into remote working, working in the cloud, working with digital technology and so on will become an avalanche with profound knock-on effects for society.

There will be incredible opportunities for the companies that survive, and for new technologies that emerge from the aftermath.

Fear is the mind-killer, so has Tweeted Elon Musk.  He’s right.  Calm heads and steady hands will get us through this.

This piece was written by Henry Humphreys as the coronavirus story unfolds over Europe and the world.

All the thoughts and commentary that HLaw publishes on this website, including those set out above, are subject to the terms and conditions of use of this website.  None of the above constitutes legal advice.  None of the above should be relied upon.  Always seek your own independent professional advice.

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