There’s no good way to estimate how many startups won’t survive the coronavirus, because nobody knows how long the crisis will last. Some companies have been fortunate enough to be in industries that are flourishing during the lockdown, such as food delivery, remote work, or telehealth. For the rest, their fate may rest on a factor outside their control: timing.
Ordinarily, startups aim to raise enough capital to last them for one to two years of operation. But with the global economy in the tank, access to new venture capital has been largely cut off. According to Pitchbook analyst Alexander Davis, 7,200 of the U.S. startups in his firm’s database were likely running out of cash by mid-March. Most of those identified probably raised capital between 12 and 18 months ago. Meanwhile, the bills kept coming. For most companies, salaries are their biggest expense, and layoffs have become commonplace across the startup landscape.
Over the past several weeks, I’ve spoken to a number of startup founders, investors, and board members to better understand the strain startups are facing. With VC money drying up, when companies raised capital before the economic contraction began will have a profound effect on which survive and which don’t. VC firms themselves are in triage mode and are changing the way they think about investing as a result. And since no one knows how long the pandemic and its economic fallout will last, many startups reliant on consumer spending will simply have to hope that the economy picks up again before they run out of runway.
Strategies to survive
Over the past few weeks, I’ve heard stories with similar themes from many VC-backed startups.
Some companies had begun putting a funding round together before the virus came, and then saw their plans fall apart as VCs began to more shrewdly assess their chances of success. Others were able to hold the funding rounds together, but were forced to accept investment deals that were based on a much lower valuation.
Stanford Business School lecturer Rob Siegel told me this shouldn’t be interpreted as VCs trying to capitalize on a hard situation. “Let’s say the company was growing slower and revenues were slowing; if I’m an investor I’m saying, ‘You’re just not going to be able to hit your plan,'” says Siegel, who is also a partner at XSeed Capital. “‘I’m comfortable with investing at a lower valuation, and if that doesn’t work for you, okay.'”
“I didn’t see them as vultures or sharks,” Siegel says. “They were trying to price risk into the deals.”
Rob Siegel, Stanford
I didn’t see them as vultures or sharks. They were trying to price risk into the deals.”
Some startup founders learned quickly that their existing VC backers wouldn’t necessarily reopen the purse strings to help. Others found the best answer was to raise small amounts from existing and new investors as a way of extending their runway.
Many startups instead went to the government for help, applying for forgivable loans made available through the Paycheck Protection Program in the CARES stimulus bill. Others chose not to borrow from the government, fearing the optics and political implications of a VC-backed startup borrowing money that was meant to help Main Street businesses retain employees.
These are all strategies toward one goal. “For 75% of startups, job one is just to survive—you can’t win the game if you’re not in the game,” Siegel says.
Siegel says he’s been attending startup board meetings discussing the effects of the coronavirus since early March, and the same issues come up in each one. “What is the company’s cash flow? What are the company’s fundraising plans? What’s the company’s runway?”
“Board members were saying, ‘Whatever your plan was, throw it out and make a new plan, and then get a backup plan in case you lose 30% of your business because of coronavirus,” Siegel says.
Changing investment plans
Most venture capital firms are currently in a “triage” mode, where they are making selective investments in their portfolio companies to keep them going during the downturn. The amount of money VCs inject into these startups is driven in part by how much time and money they already have spent.
However, VCs do have money available for new bets. The National Venture Capital Association estimates that VCs have $120 billion available to invest this year. We’re still seeing news of companies closing large funding rounds. The Menlo Park, California-based liquid biopsy startup Grail just closed a $390 million Series D round. SIP (Sidewalk Infrastructure Partnership), a spinoff of Alphabet’s smart city subsidiary Sidewalk Labs, just raised a $400 million Series A round. The fintech startup Stash said in late April it had closed a $112 million F Round on a $1 billion valuation. But many of these rounds had been in the works since the beginning of the year or even earlier.
The perceived long-term effects of the coronavirus are increasingly influencing new investment choices, as VCs looking for startups that stand a good chance of benefiting from the pandemic’s impact. For example, interest in biotech, telehealth, and fintech startups remains high, while interest in companies playing in hard-hit sectors like retail and travel has cooled way off.
At a more basic level, venture capital firms will be evaluating startups on whether their business models reflect a clear-eyed understanding that the world after the virus is a very different place, where customers and markets are fundamentally changed. Scale-at-any-cost models will be eyed with suspicion. Startups lacking a well-defined digital path for accessing their products and services will face resistance.
Looking for signs
For now, many startup CEOs are looking for ways to anticipate the restart of the economy, and the return of revenues.
Macroeconomic indicators like declines in unemployment claims, reports of job growth, and consumer spending levels may shed some light. CEOs might also look within the startup ecosystem for signs of recovery, like if the number of new startups begins to grow, if the number and size of seed funding rounds increases, or if the size of new funding rounds are larger than earlier rounds a startup has raised. All these variables connect back to the virus.
“The ultimate question on everybody’s mind is the amount of time we’re going to be living in this current environment,” said Katherine Andersen, the head of life science and healthcare relationship banking at Silicon Valley Bank, during a teleconference Wednesday. “That is, looking at the trends around the number of deaths reported—which is still rising in the U.S.—and the number of new cases still rising in the U.S., I think those are indicators of how long we’re going to be living with these current conditions.”
Katherine Andersen, Silicon Valley Bank
The ultimate question on everybody’s mind is the amount of time we’re going to be living in this current environment.”
Andersen, who sits on the boards of several Chinese startups, says the recovery of consumer confidence in post-epidemic China may illuminate how the U.S. might eventually recover. But the news isn’t good. Andersen says that while schools and government-controlled businesses have reopened, many Chinese are still anxious about entering stores and eating out.
She said this lingering effect might be even worse in the U.S. That’s because while the Chinese economy revolves around manufacturing, the U.S. economy is consumer-driven. That means consumer confidence is even more closely tied to the economy’s recovery.
Meanwhile, U.S. consumers are sending pretty clear signals that, for the most part, they’re uneasy about returning to pre-virus buying behaviors. According to a Washington Post-University of Maryland poll released Tuesday, 78% of Americans say they’re uncomfortable with eating in a public restaurant.
And confidence levels are heading in the wrong direction. In the same poll, 63% of respondents said they are very or somewhat worried about becoming seriously ill from the coronavirus. Asked the same questions in a poll two weeks ago, only 57% said they were very or somewhat worried.
Right now, the United States is in the midst of a debate between those who want to reopen the economy and accept heightened death rates, and those advocating further social distancing and isolation to suppress the virus. It’s important to be sensitive to the fact that the livelihoods of millions of Americans depend on the reopening of the economy, but experts say reopening too soon may only extend the economic pain. That applies to both Main Street companies and many venture-backed startups.
“The underlying reality is that the economic crisis is fundamentally a health crisis,” says Justin Field, the SVP of government affairs at the National Venture Capital Association. “Until we can get that new case rate down, I don’t think the economics really matter.”