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Silicon Valley investors and start-ups are stuck in limbo due to the coronavirus.
Private deals are being held up thanks to new economic risks and “shelter in place” restrictions making it impossible to evaluate start-ups in person. Tech valuations, which rely on future growth, may also take a hit.
“I don’t see too many term sheets being issued in the next two to three weeks until there’s more clarity,” said Ryan Gilbert, general partner at Propel Ventures. “It’s certainly drying up — people are worrying more about themselves and their families than they are about pitching VCs.”
The coronavirus outbreak has sent global markets into a tailspin. On Wednesday, the S&P 500 closed nearly 30% below a record set last month as it sank further into bear market, and economists have slashed U.S. and global GDP forecasts.
Meanwhile, major cities are on lockdown. San Francisco and the greater Bay Area — the epicenter of venture capital — are in the midst of a “shelter in place” order. New York City is expected to go the same direction and some international travel bans are still in effect.
Consumer investors in particular “are sitting on the sidelines” for now, according to Sheel Mohnot, partner at 500 Start-ups. Mohnot said his firm was advising “everyone who isn’t running out of cash to hold off on raising for now.”
“Deals have slowed down a bit,” Mohnot said. “Startups with high burns were already not going to do well post-WeWork, now it looks bleaker as those higher rounds of funding might be even harder to come by.”
New valuation reality
Tech valuations are based on future growth. As non-essential stores remain closed and companies face the risk of a recession, investors may lose confidence that these high-growth trajectories can continue. Shares of publicly listed companies are also in free-fall, making it hard to justify a high multiple on a similar, private start-up.
“Investors are not going to pay what they would have paid two weeks ago,” Propel’s Gilbert said. “Many companies are not going to survive on a standalone basis.”
Investors were already rethinking their investing outlooks after WeWork’s failed IPO and under-performance of some high-growth tech debuts like Uber and Lyft. Investors had been “placing greater emphasis on sustainable revenue growth and profitability, while telling portfolio companies to reduce their burn rates,” according to Nizar Tarhuni, director of research at Pitchbook.
The research firm also expects a “sustained pullback” in venture capital-backed exits, which already started slowing through the end of last year.
“The IPO market underpinned record VC exits in 2019, but that seems unlikely to repeat in 2020, with several high-profile listings rumored to be delayed,” Tarhuni said in a recent note to clients.
Some deals in motion are continuing
Well-known Silicon Valley investing firm Sequoia recently warned its portfolios that the coronavirus was the “black swan” of 2020. Private financing “could soften significantly, as happened in 2001 and 2009,” the firm said in a recent blog post.
Tomasz Tunguz, partner at Redpoint Ventures, also pointed to the financial crisis as a recent analogy. After 2008, the venture market deal flow bounced back. But it depressed valuations for between 18 months and two years.
“In a more challenging financial environment, start-ups typically burn less, so they grow less quickly,” Tunguz said in a blog post. “Slower growth means slower appreciation in company value, so the valuation multiple on ARR should be less.”
Investors still have money to put to work. Private equity and venture capital had $1.5 trillion in so-called dry powder going into 2020, according to data from Preqin. But for now, multiple investors told CNBC that debt-driven deals seem especially risky as credit markets get hit.
Still, Index Ventures’ Mark Goldberg said deal-making activity remains steady with funds working through a backlog of companies they were already in conversations with. Goldberg and other investors are relying on video conferencing products such as Zoom to go about their normal business. That presents new challenges when evaluating a young company’s management team.
“Can both parties build enough trust over Zoom calls to move forward with decisions around large amounts of capital?” said Goldberg. “We’re about to find out.”
Even as Sequoia sounded the alarm, it did highlight the fact that there are often big long-term opportunities in a crisis. For example, the firm partnered with Cisco shortly after Black Monday in 1987, Google and PayPal made it through the dot-com bust, and Airbnb, Square, and Stripe were founded during the 2008 financial crisis.