Covid-19: The Challenges In The Startup Funding Ecosystem

With face-to-face meetings put on hold due to the risk of coronavirus contagion, its quite clear – funding will being held up until investors can evaluate startups in person. In fact, some investors who had already committed money to startups and signed term sheets before the outbreak may put these deals on hold. That’s because, a startup in normal conditions can be very different during this disaster and maybe totally opposite in case it survives the pandemic.

For instance, if non-essential stores remain closed, companies operating in the segment can be at a risk of a recession. Ditto in the case of the market, which needs to be re-evaluated altogether once the dust settles.

The good news is startup will burn less in such a challenging environment and can even cut out the flab from its balance sheet. But the not so good news is that their growth will suffer too.

While these could be a short term blip, investors may still lose confidence if these firms can regain their historical growth trajectories. And this lack of clarity will surely dent valuation and investors become less benevolent with their cheque sizes. Will it become cheaper tomorrow or should we buy it today? Nobody knows for sure. And investors hate uncertainty.

As investor money begins to dry up, fewer seed stage funds and family offices will be willing to make large investments in new startups even as multiples and valuations compress. The number of IPOs could also come down or value of the exits can drop. With a smaller exit value, startups will have increased pressure to raise on smaller round sizes if they are pursuing follow-on funding.

Public valuations see the first visible impact caused by the recession. The coronavirus outbreak has sent most global markets including India’s Sensex into a tailspin – the country’s benchmark index has fallen consistently to lose about 28% of its value over the past four weeks.

As a result, investors might take a bit more time to get to know and diligence the business, compared to earlier and the bar will definitely be higher.

Also, if markets continue to fall, investors would rather focus on their existing portfolio of companies first and will be more willing to put money there because they can at least comprehend the volatility in business.

VCs will also begin to tighten their investment criteria, expecting startups to become more efficient in their customer acquisition costs and shorten their sales cycles. They will be focus on startups that can maintain cashflow instead of a company that required high marketing costs in a situation when capital allocation tightens.

For early stage businesses, investors will also see if it has realistic contingency plans apart from aggressive sales and financial targets. How to drive sustainable profitability instead of excessive growth, is what VCs will seek for in a nutshell.

In the past, VCs that have achieved one of their best return in their portfolio on funds that have bet against the odds during a recession. For instance, companies such as Uber, AirBnB and Whatsapp have all raised money during an economic downturn.

So in the end, it is about building a strong business. The companies that survived the last global recession and turned it into a thrive zone have an upper hand at present. But very few startups can boast of being there.

Financial crises have always been a filtering mechanism for companies. And startups are not an exception. But one aspect that will remain constant would be the fact that startups will keep innovating new products and services. And VC funds will have enough capital for them.

Note: We at Inc42 take our ethics very seriously. More information about it can be found here.