The effects of the COVID-19 outbreak will reverberate through society and our economy for decades to come and will transform the way the world operates for the foreseeable future. That’s frightening to a lot of people right now — change always is. Inevitably, after any crisis, especially one as widespread and global as this, there will be a change of behavior in human interactions, business interactions, business operations, business conduct, healthcare, the regulatory environment, security, and more.
Take 9/11 as an example. Once the dust settled, there were many changes to the way we traveled — air traffic, airline reservations and ticketing, luggage handling, airport and airplane security, the invention of TSA, even food service — down to the utensils on the planes. That’s not even taking into account the creation of Homeland Security and all the impacts in government oversight and other security measures inside and outside of the country.
The net effect of the coronavirus-driven downturn will be that adjustments that would normally happen gradually over years is now going to be crammed into a matter of months. There will be pain in the transition, no doubt, but also progress. Here’s what that transition is going to look like in the VC investment landscape.
The effect on valuation
The top-of-mind question for entrepreneurs and investors right now is not surprising: How does this downturn affect company valuation? The answer is simple but predictably disappointing for private companies looking for capital: Valuations across the board are going to shrink, possibly as much as 30-50% compared to what they were a year ago. We’re entering an age of extreme conservatism. The public markets are weathering a severe hit, and that’s going to reverberate across all private investment markets as well. In the past few years, as public markets and the economy grew faster than ever, the investment philosophy had turned toward “company friendly” terms. Going forward, at least until the rate of growth reaches the measures we saw recently, those terms will become more “investor friendly.”
Founders and management should expect investors to apply much tighter forces to valuation exercises, and money will not flow nearly as freely as it has in the past. But we’re going to see an acceleration of another force to counterbalance this constriction: the active involvement and guidance of experienced VCs in their investments. In an age of conservatism, VCs will increasingly roll up their sleeves and participate in the strategy and decision-making behind their investments, and this will be welcome guidance among a generation of entrepreneurs tasked with doing more with less.
A return to lean, mean startup operations
Going hand-in-hand with lower valuations will be harder questions from VCs, especially related to the stability of a company’s revenue stream, the way it’s managing cash, and the clarity of its path to profitability. The era of long-shot investments in companies that burn cash fast and have yet to clarify the timing and way in which they’ll achieve financial success is over. Now is a time for sensible financial management, not just big ideas — but VCs will ideally be looking for the right combination of both.
VCs will increasingly evaluate new businesses on their ability to weather sudden storms. Models based on recurring revenue, like subscriptions, that require low upfront cash infusions will be more appealing than ever. Think of the cautionary tale coming out of the scooter rental startups right now: Millions of dollars in equipment are lying on city streets in support of an unpredictable, non-recurring revenue stream that has all but dried up. Investors are unlikely to barrel down a similar path anytime soon. We’re in survival-of-the-fittest times: Lean companies will ride this storm out thanks to the cash they’ve kept on their balance sheets, and bloated, cash-gobbling organizations will need to either shed fat quickly or close up shop altogether.
The new requirements for effective business models
Let’s state the obvious: Certain business models are going to fare better than others in the back half of 2020 and beyond. While the past decade belonged to disruptive, consumer-direct businesses that redefined brand relationships, the next decade will belong to those that rethink the role of human contact within a transaction and prioritize efficiency, adaptability, and sustainability.
In the current environment, we’ve seen e-commerce businesses emerge as clear winners, but traditional retailers like Walmart and Target have also been presented with an opportunity to scale up online operations as consumer scramble to secure supplies. The options that these companies are enabling among consumers, including new groups who were previously slow to shift to digital transactions, will become the new normal. Nimbleness within the supply chain will also become a highly prioritized factor among consumers and investors alike.
It will be vital for companies going forward to account for the new behaviors and consumer expectations that will emerge from this pandemic. Think about the massive shift from in-person events and meetings to Zoom and other online conferencing. In many cases, these aren’t short-term survival tactics. They’re new behaviors that many people are enjoying for the efficiencies they offer. These are new social norms that will be top-of-mind with investors. Beyond communications, healthtech and insurtech companies will be positioned well going forward, as consumers realize the importance of online transactions beyond retail and practitioners accept and accordingly transition to online options.
Within these industries and others, software-as-a-service (SaaS) platforms are going to have an advantage in a post-pandemic investment landscape, by virtue of their recurring revenue streams and ability to scale quickly. Thanks to their cloud-based natures, these businesses typically operate remotely and conduct business in a contactless way — two major virtues in the current and future landscape.
Without a doubt, there will be newcomers to the market that provide new and niche technologies that fit our new norms: work from home, remote access, new security and health measures, telemedicine and telehealth, contactless payment and transactions, virtual showrooms of all kinds, potential virtual travel — even StarTrek-like human transports!
A lot of businesses are going to get left behind by the pandemic and subsequent recession, particularly those that put their heads in the sand and fail to evolve. But as with any downturn, the cream will rise to the top, and investors will be eager to align themselves with the new generation of companies that stand ready to meet consumers’ and businesses’ post-pandemic needs and expectations. Now isn’t the time to simply wait things out. Now is the time to reorient mindsets and models for the future.
Mike Abbaei is Co-Founder of Naples Technology Ventures.