How to Ensure Startups Survive this Crisis — A VCs Perspective

I found myself participating these days in different interviews and video podcasts, answering many questions asked by entrepreneurs and venture capital investors. I’d like to share a few thoughts here as well:

Alex Lazovsky, Managing Partner of Scale-Up VC
Alex Lazovsky, Managing Partner of Scale-Up VC

How VCs respond:

All experienced VCs, including our firm Scale-Up, have already proactively responded to the crisis by the end of February, early March. We have all talked to our CEOs and called for extraordinary board meetings. Sequoia has released its open letter to the founders and CEOs on March 5.

Most VCs who arent new to this business put all their attention on their existing portfolio companies prepare the companies for the recession and, if needed, ‘tighten the belt’ by making burn rate reductions (layoffs, furloughs, pay cuts, etc).

We instructed even those of our portfolio companies who have enough cash on balance for the next 18 to 24 months (which is pretty rare for startups) to freeze new hires and optimally reduce expenses.

We have started internal rounds of financing in companies that urgently need additional capital, without counting on any external investors. Some companies will go through down-rounds and complex recaps to raise necessary capital now. We already anticipate a long recession ahead and we need some of our companies to become more realistic in terms of valuations and other terms and get better prepared for next rounds with external investors in a year from now.

It depends on how many companies each VC firm has in its current portfolio and how many managing partners can deal with that. In general, it takes most of the bandwidth of the key people managing the VC firm.

Those of us who are at the beginning or in the midst of the investment period in the current vintage of the fund is not going to stop making new investments, but the pace and volume of new investments will have a dramatic slowdown.

First, we are still very busy with portfolio companies. Second, the most important factor in the investment decision is meeting the founders face-to-face and spending some “flight hours” together during the due-diligence. Lack of face to face meetings with startup teams makes it extremely difficult to make new investments and slows down the process.

This is not the first time it’s happening. In 2007–2009 the deal value of VC investments fell down by ~25% in late and growth-stage deals and by ~35% in early-stage deals.

The Market Crash. The Recession. The Recovery.

The phenomenal market growth we all enjoyed in the last decade is over. It all collapsed in March by about 40% within a few weeks. For those who still think it will all recover quickly, let me share few observations with you. In the last 91 years, there were 12 market crashes and each time it fell by at least 40% it took over 4 years to recover. The steepest the crash and the longer it takes to get to the trough, the longer it takes for the markets to recover. The most recent market crash of 2008 took almost 4 years to fully recover. The oil crisis of 1973 took almost 6 years to recover. Today we have both! Stay-home/shelter-in-place orders are now placed all across the globe and in the U.S. alone 80% of people are forced to stay at home. The market didn’t reach the trough yet. Those who see optimistic spikes and think it’s a good sign of recovery must consider that each market crash had numerous false short rallies, some reaching 25%; there are reasons for that, but this is not a sign for recovery.

The Layoffs:

17 million people in the U.S. filed unemployment claims since the beginning of March.

There will be massive layoffs in the tech sector as well. Some tech companies have already started massive layoffs in March and over 200 startups fired close to 20,000 employees by now.

Silicon Valley accounts for the largest share of that, about 30%.

Bird Rides fired over 400 people in a few minutes over Zoom. Yelp announced 1,000 layoffs and 1,100 furloughs. Eventbrite laid off 45% of staff, including 450 employees in the San Francisco office alone. Thumbtack and TripActions each laid off over 250 employees. 95% of the revenue of ClassPass, which offers a membership program for fitness classes, evaporated in a few weeks as studios and gyms around the world shut down.

The largest tech corporations will most likely start massive layoffs soon. All budgets will be reduced, impacting all kinds of projects, even relatively inexpensive outsourced R&D.

On a positive note..

VCs like myself have seen such recessions more than once. We do not have illusions, instead, we react immediately.

The most positive thing is that over the last decade since the last recession, the digital revolution has provided many companies with the opportunity to continue operations, sales, customer support and even introduce new products and services remotely via video, chat, Instagram, Facebook, and other digital channels.

Many of today’s tech giants were established or survived during recessions and crisis times — Airbnb, Square, Stripe, PayPal, Google, Cisco, and many others.

Many good tech companies will survive this time too. We will not let our best portfolio companies fall in any crisis, including this one.

During days like these, great founders will come up with new creative ideas, some of which will evolve into future big success stories.