The Investment Outlook

Who'd have thought that the last three months would see unprecedented growth in most public markets as stock pickers bet on a swift recovery from the pandemic? Had you bought at the bottom of the market three months ago you would be sitting on c25% growth in most stocks and literally hundreds of percent in the case of darlings of the pandemic like Zoom.

Whilst this bull run may have a bit more to go or maybe will prove to be a false dawn if we are hit with a large second spike it is, as ever more difficult to discern what is going on in the far less liquid markets of EIS and venture investing.

In a recent article, Paul Flanigan identified four very distinctive stages for VC's and we are very much still at stage 1.

Stage 1: Triage.  VCs slow down looking at new investments. They instead decide which of their portfolio companies they should continue to support and how to best ensure their survival and, eventually, their growth.

Stage 2: Market exploration. We’ll move to this stage fairly quickly. VCs will begin taking meetings again with entrepreneurs, but their true goal won’t be to identify possible investments (a point they won’t reveal to founders). Instead, they’ll be gathering intelligence about what’s happening in the market.

Stage 3: Risk-averse investing. When VCs get back to making new investments, they’ll do so very cautiously, and they’ll be looking for reasons to say no. The pace of investment will be slow, and they’ll be most interested in 1) companies with a capital-efficient model that shows some growth and 2) businesses that will benefit from changes in the market (e.g.: think remote learning).

Stage 4: Opportunity. Once the economy shows visible signs of improvement, VCs will begin acting on opportunities. Their mindset will change from looking for reasons to say no to looking for reasons to say yes. It’s a subtle shift, but it makes a huge difference in determining which companies will get the green light.

Keep in mind, I’m painting the situation with a bit of a broad brush. VC firms differ in their investment strategies, and their thinking will change depending on how long ago they raised their current fund. One that closed on a new fund just before the pandemic will have different expectations from their limited partners than those managing funds that are five or six years old.

Timing is everything

How should startup CEOs and entrepreneurs proceed? Foremost, realize that unless you have a business that is seeing growth due to changes in the market caused by the pandemic, now is not the optimal time to look for funding. If you do manage to secure a VC meeting, try to identify what stage of investing the firm is in to help guide your conversation. It’s unlikely firms will make significant investments outside of their existing portfolio for a while, so you’d be better off focusing on starting the process of establishing a relationship and nurturing a potential investment down the road. If you’ve got an existing company that needs capital, your priority should be your current investors. They’re in the midst of triage, after all, so you’ll want to demonstrate to them that your company is worthy of continued support.

In the meantime, lay the groundwork for growth in Q3 and Q4. Due to uncertainty in the markets, many companies could take a hit in Q2 which could roll into Q3. Make your operations capital-efficient, and focus on increasing customer satisfaction and continuing product development, so you can start trending upward again when we start to recover. When VC investors do come back to the table, they’ll still need to see some measure of growth to attract their interest, though, potentially, not as much growth as they expected prior to the pandemic.

In enterprise tech, you really need to have a cloud or software-as-a-service (SaaS) model. VCs are going to be very leery of investing in anything that needs to be deployed in a data center. The enterprise was already moving quickly to a cloud-only model. The pandemic has accelerated that transition now that businesses have had to support massive numbers of employees transitioning essentially overnight to remote work. The cloud/SaaS model has been proven, it’s cost-efficient, and all it takes is an internet connection and a browser for users to be served.

If you’re in enterprise technology, the cloud is not your future. It’s your “now.”

No matter what industry your company is in, however, this is not the time to burn a lot of money chasing growth. Capital efficiency is in vogue again, and good fiscal control is always appealing. The days of investing hundreds of millions of dollars into shiny rocket ships that burn money like jet fuel are done, at least for the next couple of years. Instead, focus on the leverage in your business model. Driving capital efficiency, customer satisfaction, and product innovation — these are the foundation for growth when the economy begins to turn around, and you’ll need growth to attract investment.

When the opportunity stage arrives, there will be people interested in you who just months ago were searching for the next unicorn. But crises have a way of bringing ideas back down to earth in favor of less sexy but more proven, fundamental options. A good business will always attract investment. The Dow may not get back to its highs very soon, but investors will always go back to good companies.

Angels on the other hand are rushing in much more quickly. Recent research by Crowdcube indicated

94% of investors think it is important, now more than ever, to support businesses they believe in

·      94% of investors said that if the opportunity to arises to invest in a business they believe in, they are still open to investing in light of Covid-19

·      65% of investors think that EIS or SEIS tax relief is more important now in light of Covid-19

And the numbers don't lie, the total investment on this platform alone was £7m in March, £10m in April and over £15m in May which is within about 10% of 2019 numbers.

So if you are looking to raise now, don't despair, make your proposition COVID relevant and go for it!

Good Luck!!

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