Total clean-up: only the strongest will remain on the venture capital market after the pandemic

зачистка после пандемии на венчурном рынке

Even before the crisis, “reproduction” was outlined in the venture capital market: investments grew, but yields fell. Today, those corporations that still have not felt the benefits of external innovation or simply paid tribute to fashion will significantly reduce or eliminate their venture capital divisions, but truly effective venture capital teams will not be affected so much.

So, let’s start with what venture capital funds are. A venture fund is a risky investment fund focused on working with innovative enterprises and projects (startups). Venture capital funds invest in securities or shares of enterprises with a high or relatively high degree of risk in anticipation of extremely high returns. As a rule, 70-80% of projects do not bring returns, but the profit from the remaining 20-30% pays for all losses.

A feature of this type of funds is the legislative permission to carry out more risky activities: there is no need or a sharply reduced need for risk diversification, they are allowed not only to buy corporate rights but also to lend to companies (for example, through the purchase of bills). The only thing they are forbidden to do is invest in the banking, insurance, and investment sectors.

Corporate venture capital funds are small and highly efficient teams consisting of motivated above average employees. Even in the “pre-coronavirus era” they were used to working remotely because it is the specifics of working with startups around the world. The effectiveness of small teams of corporate funds is a good guide for other divisions within companies: because the more flexible the structure is, the more stable it is in times of crisis.

Corporate venture capital funds on the eve of the current crisis were not only a fashion trend but also a growing business. According to CB Insights, corporate venture capital investment has more than tripled over the past five years: from $18 billion in 2014 to $57 billion in 2019. The main tone is set by Asian and American players such as Samsung, Google Ventures, Intel, Baidu, etc.

As different industries felt the breath of “disruptive innovation” in the 2000s, the need for practical tools to work with them grew. Not only IT corporations and digital giants created venture funds, but companies from various industries also began to show interest. However, this was due only to practical goals: venture capital investments were seen as a quick way to make your business more digital and more convenient for customers. Indeed, against the background of more mobile and flexible online platforms in retail, tourism and other industries, traditional players were noticeably losing, and the lag in the introduction of new technologies threatened to crash many large companies with a glorious history – moreover, the collapse was not in some distant future, but in 3-5 years perspective. In addition to the financial and consumer sectors, disruption also attacks the industry. For example, the capitalization of the famous General Electric fell three times in 2017-2018 against the background of the fact that its energy division began to lose ground due to intense competition from the sun and wind power.

Competition from alternative energy sources stimulated the creation of venture directions among oil and gas giants who were looking for breakthrough technologies in order to “reinvent” themselves in the new energy sector and diversify their business. In recent years, energy companies have also begun to focus on carbon footprint reduction projects.

Of course, conservative industries (metallurgical, engineering, auto industry) could not afford to stay away from the global trend. They not only thought about developing their own ecosystems but also launched their own venture funds, expanding the familiar and comfortable boundaries of the main business. It’s interesting: today corporate venture capital funds are already participating in every fourth transaction (that is, the share in the total number of transactions is 25%).

Who is the loser?

The first victims of this crisis were small and medium-sized businesses, as well as representatives of the tourism industry and the airline. Large corporations felt the change with a slight delay.

As for venture capital investments, the crisis will come last, shifting the current focus to working with portfolio companies and stimulating the search for a new identity. And this is good since problems in venture capital have already matured. Despite the rising investment, yields have fallen in recent quarters. And they will continue to fall, which is a sign of “reproduction” in the market, in which more and more money is invested. But the implementation of transactions through their successful monetization is lagging behind.

Already in the first quarter of 2020, analysis based on data from Pitchbook, Crunchbase, and CBInsights shows a decrease in the number of transactions by 5-7% and their volume by 15-20%, and estimates during the rounds are reduced by 10-30%. The fall is not the most dramatic. This is a temporary lull, mainly due to an attempt to realize the COVID-19 crisis in late February and March. While a huge number of industries were at the epicenter of the storm at that time and the fall was multiple, the venture capital industry fell not so dramatically. Why is the venture capital market facing a crisis later than the rest?

The secret lies in the very structure of venture investments: the market is represented mainly by funds with a limited period of fundraising and investment. The funds have already collected obligations, funds have been fixed, and they need to be invested in a certain period. Of course, today it is no longer necessary to expect that huge new capitals of mega-funds will enter the market.

The current situation is most likely to benefit those companies that managed to raise funds but did not invest them. Evaluations fell, and the choice of startups increased significantly. Those representatives of venture who were attracted by investments some time ago and today spent almost all of them were less fortunate. Now entering the market with a finished product, solution or service will be especially difficult, and some portfolio with fundamentally good business may cease to exist or go bankrupt. Those who are just about to create funds are in the most deplorable state since they will have to either lower their ambitions or completely freeze the idea until the economy recovers.

New opportunities for corporate venture

As for the startups themselves, it will be most difficult for those who raise funds in the early stages of their development, for example, those who are looking for investors “for an idea” or even “for a prototype”. On the other hand, it is safe to predict that it is during this period that a huge number of new “unicorns” will appear that can prove viability in the new reality. It is also important to note that the founders of new start-ups are often ex-employees of large technology corporations who have been cut or left the company themselves but turned the situation in their favor by launching a startup. Take a look around: perhaps you have a chance to become the new Sean Parker and the first investor in the new Facebook!

Startups that have reached steady revenue or even profit and raise funds to scale their businesses are now feeling much more confident. They are the least risky asset in terms of investing on the part of those funds from which funds have been collected and which are in active search. It is worth noting several more advantages of such companies: they are not the first year on the market, contact with funds has been established, they are easier to analyze based on financial indicators.

But the greatest opportunities are opening up for corporate venture capital funds, which have two crucial resources behind them – investment and vision. Harsh times provide excellent opportunities to either strengthen some areas or even create new ones. It is today that opportunities are opening for the purchase of what was not sold before, or of what was too expensive. However, only those companies that have access to deal flow (the flow of investment offers) will benefit from this situation, and these are primarily well-functioning corporate venture funds.

The vision is necessary in order to correctly build the logic of investments not for one or two transactions, but for the future, to create a whole portfolio of investments in breakthrough technologies. Possessing this vision, corporate venture capital funds adhere to the plan and do not deviate from it even in such historical times, which we have witnessed.

The specific conditions of the current crisis didn’t actually so much affected the effective venture teams. Of course, due diligence has become much more difficult, and in the case of offline technologies (for example, the development of new alloys or materials) it is almost impossible. At the same time, the term “GoPro management” has now appeared in production startups, which means that production processes are rebuilt and improved using webcams. Perhaps, after some time, GoPro due diligence will appear.

Funds that were geographically close, such as Silicon Valley, are now unable to communicate with companies. For the rest, it is definitely a plus, as it gives a chance to be at the same level of access to high-quality companies with competitors located in innovation centers. However, it is important to consider how well-developed network the companies had before the crisis – after all, little can replace a personal meeting.

Finally, now is the time to spot venture tourists. Those corporations that still have not felt the practical benefits of external innovations, or those that simply paid tribute to fashion, will significantly reduce or completely eliminate their venture units, and the allocated funds will be frozen until better times. For them, like for ordinary tourists, “traveling” in venture landscapes in the new conditions will be very uncomfortable.

Corporate venture capital funds, which will show their best sides in working with the existing portfolio and new investments, can strengthen the reputation and attract attention from the point of view of a competent approach to working with startups. Whoever fails to do this will have to come to their senses long after the pandemic.

The main thing is to continue supporting entrepreneurs at all times, regardless of external factors, daily proving the effectiveness of technologies to achieve corporate goals. And, of course, be able to maintain and expand a motivated and effective team. After all, a crisis is the best time to invest not only in companies and technologies but also in people.