- We don’t yet know the full impact from layoffs, the slowdown in global connectedness and shifting capital dynamics or the life-changing impacts of the pandemic and our demands for social justice, but there are strong signals that the broader tech economy is pulling out of a tumultuous first half of 2020 in good shape.
- Strategic investors, particularly those who have been through down cycles, are looking for companies that are focused on innovating over the long term. They’re seeing it as a chance to look at deals they may have passed on a few months ago because of terms or valuation sensitivities.
- Emerging managers, by their nature, don’t have legacy portfolios with large cost structures to manage. This allows for more flexibility and the ability to pivot. But raising capital is hard and we envision more collaboration among this critical class of investors.
Given where we’ve been, what is your best outlook for the rest of 2020?
If there is a constant in 2020, it is change. While uncertainty makes doing business harder no matter the sector, the tech industry often proves itself more adaptable than most. We don’t yet know the full impact from layoffs, the slowdown in global connectedness and shifting capital dynamics or the life-changing impacts of the pandemic and our demands for social justice, but there are strong signals that the broader tech economy is pulling out of a tumultuous first half of 2020 in good shape.
From our perspective, the first four months of 2020 continued the 2019 trajectory of strong capital raising—then we hit a major inflection point. What was going to happen to fundraising starting in April? Apparently, it continued to cruise ahead. We saw continued closure of many mega-funds. True, most of the capital raised in Q2 2020 was already well into the diligence pipeline before catastrophic global events had to be factored in; however, we believe 2020 will still shape up to be a plentiful year in terms of dry powder and fresh capital ready to deploy into the innovation economy.
Where is the capital being invested?
Most investors have triaged their portfolios, targeting 18 or more months of cash for their winners and streamlining as best as possible their “non-winners.” Now, many investors are watching and waiting for valuations to settle down. They are making opportunistic investments in their top portfolio companies and getting in touch with high-quality companies and founders to explore new deals. While terms have largely shifted to favor investors, the most exciting deals are still proving competitive. Many strong companies, thanks to their 18+ months of runway, don’t have to play ball with unattractive terms…yet.
So, what do we know? Core fundamental businesses are still highly prized and have deeper cash reserves than we saw in past downturns. There is also still plenty of dry powder on the sidelines, waiting to be deployed. The guessing game is where that capital goes: to tried-and-true businesses that are ramping growth, disruptive new businesses building for the “new normal,” or somewhere in between. Can investors realistically bet on a public exit, or do they need to reserve capital for new ventures for a longer time horizon? What will M&A activity look like? As investors weigh these predictions against their own portfolio construction, we will see shifts in funding from certain profiles to others. But for now, the money still seems to want to flow into the tech ecosystem.
What other shifts in investor sentiment do you see?
First, what has not changed: VCs with capital want to put it to work. They are excited to get in at today’s (or tomorrow’s) lower valuations, with streamlined business models focused on core disruption and minimizing burn. There was initial resistance to committing new capital, in part because in-person due diligence was hampered by shelter-in-place rules, but we are seeing workarounds. Investors and entrepreneurs are getting creative with new ways to get to know one another. That’s not to say it’s easy to raise money right now. Investors want to see data and hard performance metrics; they don’t want to pour capital into in-the-moment business plans that may not prove durable. Mostly, they want to be strategic in not just whom to bet on but when to make the bet.
Strategic investors, particularly those who have been through down cycles, are looking for companies that are focused on innovating over the long term. They’re seeing it as a chance to look at deals they may have passed on a few months ago because of terms or valuation sensitivities. These investors are quick to remind us about successful fintech companies, such as Venmo and Square, that were born from the ashes of the 2008 global financial crisis. Now, we hear excitement around the potential of infrastructure security, healthtech and care delivery, distributed workforce, remote learning, and e-gaming. I’ve personally heard more discussions around education and the creative arts (both traditionally analog sectors). The future looks bright for new revenue models and consumption modalities.
What are corporate venture investors thinking now?
Several consumer and manufacturing trends that were already accelerating before the pandemic are moving at warp speed. Corporate America is realizing, if it hadn’t already, that it’s innovate or die. Corporate venture is a logical path to gain access to new technology and visibility into the future, and it may be a good time to double down. But gaining the support of the CEO and board, especially if you are in the middle of layoffs or other cost-cutting moves, may be difficult. I do think corporate venture activity will become more closely aligned with the core business, as there will be less tolerance for exploring true white space well outside the primary business of the parent company.
How are emerging managers and small investors navigating this environment?
My SVB colleague Jim Marshall, head of the Emerging Manager Practice, believes that the fourth wave of venture— generally investors who have more diverse backgrounds and networks—is well underway. We think there are several reasons to be optimistic. Many of these managers have closed funds in the last 18 months, seeking to weather last year’s predictions of a 2020 downturn. They have become more “institutional” in their thinking and structure, and many are serial entrepreneurs who have unique perspectives on what the future may bring. Emerging managers, by their nature, don’t have legacy portfolios with large cost structures to manage. This allows for more flexibility and the ability to pivot. But raising capital is hard and we envision more collaboration among this critical class of investors.
You are on the board of the newly formed Venture Forward, a nonprofit arm of NVCA focused on diversity initiatives. What does the industry need to do?
In a word, change—and I don’t say that lightly. Progress has been too slow. To solve the world’s biggest problems, we need the brightest minds, the best ideas, and the most disruptive viewpoints we can find—and that won’t come from staying only in the lanes we’re used to. If there is one thing successful investors know, it is that breakout opportunities are most likely to be found where everyone else is not looking.
Venture Forward is exploring ways to make sure the venture community gets connected to the widest sources of disruptive innovation by educating and training the next generation of investors, improving diversity in the industry, and expanding venture activity to new regions. Key drivers are to set goals, measure progress and insist on transparency. And it must include accountability. I believe that there are outsized economic returns for people who embrace broader perspectives, markets and sources of disruption. Learn more about Venture Forward.
What have you taken away from the past few months that gives you confidence in the industry?
Many of us have new insights into human interaction and balancing work and home life. Merging work and personal life isn’t easy, but there are some surprising positives. You have a new window on the world of your colleagues, and your family has a new window on you: how you balance responsibilities and divvy up chores, resolve issues and process highs and lows. It can be uncomfortable, but on balance it leads to more honest conversations, which, not coincidentally, is a great way to start a discussion about diversity and belonging in our industry.
Businesses and investors that understand how to incorporate and maximize diverse points of view will create new opportunities for themselves, their employees and their partners. At SVB, we are committed to fostering a more diverse, equitable and inclusive environment within the bank and across the innovation economy. I hope the experiences of 2020 help more people want to look beneath the surface, appreciate different viewpoints, and see the world— sometimes quite literally—through a different lens.
Let’s grab the opportunity.
This article appeared in the Pitchbook-NVCA Venture Monitor report. Read other articles and learn more about our partnership.