Venture capital investors who support their portcos can outperform in this crisis

Authored by: Aaron Fu
May 29, 2020 - 6 mins read

What is so exciting about venture capital? Dan Kimerling, Founder and Managing Partner at Deciens Capital — an early-stage fintech investment firm based in Silicon Valley, a member of the Catalyst Fund Circle of Investors, and an investor in Catalyst Fund portfolio company Chipper Cash — cited two reasons at a recent Catalyst Fund investor community webinar.

The first is perhaps obvious: venture capital capitalizes on the exponential growth experienced by (very few) early-stage companies. The second reason – one that is extremely relevant to our COVID-19 reality – is that historical trends reveal very little correlation between venture capital performance and significant macroeconomic and political volatility. As such, venture capitalists (the good and lucky ones), can anticipate continued profits even these turbulent times. 

Dan pointed to the example of Compaq, which rocketed to $100 million+ in revenue in its first year of sales – the first ever startup to hit that milestone so fast – during a severe recession. A decade later, during another recession, the internet was born and Cisco, Yahoo, Amazon and many others created tremendous value for investors. More recently, the 2008 economic crisis birthed some of today’s most successful tech unicorns: Twilio, Airbnb, Uber, Square and many more.

Dan joined the Catalyst Fund investor community to spark a discussion about how investors should be approaching these uncertain times. He provided insights about evaluating your portfolio in changing circumstances, reminded us of the need for frank, hard-nosed conversations with founders, and highlighted the opportunity to support innovative startups. 

Consider your portfolio trajectory

Investors need to reassess their portfolios as the world around us is changing. When making a deal, investors ask themselves: “What has to happen for this company to become one of the most important companies in a generation?”.  As the world changes, the answer to this question will almost certainly change as well. Portfolio managers are likely to adjust their feelings about who will be generational winners, as well as the conditions necessary for that to happen. 

The good news is that early stage companies can be, by definition, less impacted than later stage companies because they are still developing their product-value proposition, and can adjust and adapt to new circumstances. On the other hand, they might have less capital to work with to survive the worst.

Taking into account how he sees our new reality unfolding, Dan shares three categories into which he’s placed his portfolio companies:

  1. Will work immediately: Is this company working in the new current context? If so, we need to make sure we support them, potentially with double down financial and human capital. 
  2. Will work on the other side: Is this company going to work in the new reality after this disruption, considering the distribution of what these disruptions could look like? How do we support these companies? 
  3. Will not work on the other side: These are the hardest decisions to make, but determining whether business models will work on the other side of this disruption is critical.

Once each company is slated to a category, the key question is, of course, runway. If a company has 12+ months of runway, then it might be possible for a company in group 3 to reinvent itself – indeed now might be a great time for that reinvention. Similarly, a company in group 2 can extend their runway to survive until their product becomes relevant again.

The tougher situation is when an early-stage company does not have a lot of runway. In these circumstances, investors need to decide if the company is in group 2 or 3, and if they have enough conviction to provide the bridge. 

Making that call can be difficult, especially in emerging markets and among early stage companies. Moreover, many investors in the Catalyst Fund Circle of Investors are focused on other measures of success, like socio-economic impact and innovation for underserved and vulnerable segments. Furthermore, it may be harder to predict circumstances in more volatile markets like Nigeria, or to imagine how consumer preferences will evolve in markets that are leveraging the crisis to make dramatic strides towards digital inclusion. 

Communicate with and support your founders

Regardless of your measure of success, once investors have categorized their portfolios, it’s imperative to communicate this thinking to the portfolio effectively. 

Dan notes, “If there’s an entrepreneur in my portfolio that doesn’t know where they stand with regards to my view of where they are…, I haven’t done my job as a portfolio manager.”

That said, it is critical to start with a high degree of empathy. Dan reminded our investor community that “these entrepreneurs have put years of their lives into building these companies, and they’re facing evaporation, or at least material risk, overnight.” 

These will be hard conversations, but we must remember to start by treating entrepreneurs as humans with hopes, fears, dreams and uncertainties, as well as leaders who are also shouldering responsibilities and absorbing the anxieties of their team. In these months founders’ own teams will be stressed and they will need to be the vessel for their whole organisation’s emotions. Being an investor or a member on their boards is both an honor and a responsibility, and the job is to support them through these times.

Helping an entrepreneur through this psychologically is almost as important as getting them through it financially. An often underlooked role that investors (especially lead investors) have is to provide value and strategic support to entrepreneurs in their portfolio. Investors should recognize that times of crisis means they need to roll-up their sleeves to help get the work done and get through this crisis. For founders, an investor’s ability to add value is crucial as they want to bring in people who will help build and shape the company. It’s important to go back to this critical role when times get tough.  

Reassess your own processes

Members of the Catalyst Fund’s Circle of Investors agreed that Series A rounds are absolutely still happening, but it is difficult to get investor attention and conviction since their traditional ways of working have been disrupted. Many VC firms are used to going into offices for partner meetings, and for due diligence reports to come directly from in-depth, on-the-ground, face-to-face conversations. 

Many have had to re-learn how to do what they do in this new, remote, business environment. Some are adapting better than others, especially ones that are strong at conducting remote due diligence (even if they had not exclusively relied on this before), but some firms are struggling to get consensus on deals without their traditional flow.

Necessary adjustments include reconsidering the vision of success for early stage startups. Dan hopes that this crisis triggers a more deliberate and considered approach to the question of whether raising a Series A is should be the end goal for seed investors. There has been a perception that raising more money is obviously a good thing, that getting markups is an obvious good thing for both investors and the entrepreneur. 

However, if the company is profitable but not a rocket ship, raising a series A may not be the right choice. It creates a situation where a sub-$50 million outcome is no longer a good one for the parties involved. For example, for an enterprise SaaS company that is growing revenue at a strong 5% MoM but does not have a clear path to rapidly increase that 5% growth rate, a Series A may not make sense. Perhaps the more sensible thing for both that company and their seed investors is to let it grow at 5% MoM for a couple of years. After all, that growth is still creating significant enterprise value, and there will be other ways to finance cash flows aside from a Series A. 

At Catalyst Fund, we regularly dive deep into this question with our founders as well. A “growth at all costs” strategy is not wise for businesses that are still establishing their business model and sustainability fundamentals. Instead, we point them towards focusing on product market fit and unit economics, as well as user experience and retention to ensure that their customers value the company and its offerings in the long run. Many investors have articulated a similar point of view (see Lauren Cochran, and Alez Lazarow) arguing that startups should adopt longer-term thinking and focus on profitability . 

We also have in-depth conversations about what kind of capital is right at what time. This is one of the starting points for our investment readiness sprints, in which we work with our portfolio through open and honest conversations to understand exactly how further capital will accelerate their growth trajectories, while also considering alternative financing mechanisms.

Crises are opportunities too

A number of investors, including Deciens, are proactively arming their companies with significantly more capital in this period of flux, especially those companies that fall into the earlier mentioned categories of being able to do well during and/or immediately after this crisis. 

There are also good reasons to think about new investments. To start, as many startups close and companies downsize, there is much talent looking for a great home right now. Furthermore, changing circumstances and urgent new needs mean that agile, lean startups are well positioned to deliver creative, innovative solutions as old products and ways of doing no longer work. Catalyst Fund startups are finding these opportunities, and we are supporting them as they find new ways to benefit the underserved. For example, Sokowatch is leveraging its e-commerce platform to get food and essential goods to the most needy in Nairobi.

Even in this moment of crisis, there are many opportunities to deploy capital into high-quality companies solving big challenges, all while building attractive value. It is important to not let these startups down, and to double down on the innovators who are coming up with creative solutions to the world’s toughest problems. As an investor, if you can find companies that are doing well in this context, now is a great time to be making deals. Deciens, for example, is planning to do significantly more deals in these months than it has in similar periods over previous years. They are not letting this crisis go to waste.

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