Start-ups and Venture Capital in times of the Corona crisis
The effects of COVID-19 are becoming increasingly evident throughout the global economy. Stock market indices are collapsing, governments are stirring up rescue packages for companies and the “black zero” is a thing of the past. Of course, it is not only established companies but also young start-ups that are being hit by the crisis. Young companies are often dependent on external financial capital, provided by so-called venture capitalists. Prof. Dr. Katrin Burmeister-Lamp and Tom Orben (PhD student in the field of Entrepreneurship & Innovation) asked themselves: What consequences does the crisis have for this relationship and what risks do start-ups face?
For investors, a recession is actually a good time to invest. This is especially true for classic venture capitalists that invest high-risk capital in start-ups. If they have either recently raised capital or generally still have sufficient capital available, they may benefit from lower valuations of start-ups in the future (mobihealthnews, 2020; Crunchbase, 2020). In a crisis, investors therefore get more shares for less money. There is a whole range of data showing that investors who actively invested during an economic downturn achieved much higher returns than funds in a “bull market” (mobihealthnews, 2020). VCs are investing money today that they raised yesterday. They may be more cautious in their choice of start-ups (can these companies endure a downturn?), but this year we are unlikely to see a dramatic drop in funding. Some prominent VCs (Lakestar, Holtzbrinck Ventures) have already announced in interviews that they are still looking for new potential investments (Crunchbase, 2020; Gründerszene, 2020).
The situation is different for so-called corporate venture capital companies. These obtain their capital from established companies and invest it in young start-ups. This means that they do not act independently (like traditional VCs) but are usually closely linked to their parent company. These parent companies are currently using all their resources to deal with COVID-19 themselves, and priorities are shifting accordingly (Gründerszene, 2020; mobihealthnews, 2020). Thus, deal flow in the CVC environment will probably slow down for a short time. This decline is already reflected in Q1’20. The global CVC financing volume fell by 13% to $34B compared to Q4’19. The number of CVC transactions fell by 19% in the quarter to 1,337 in the same period. Compared to Q1’19, this is a decrease of 24% (CB Insight, 2020).
What may be positive for VCs (falling valuations) is of course negative for start-ups. Raising new capital under attractive conditions will probably be difficult in the near future. Since CVCs are reducing their investment frequency, this financing alternative may not pose a valuable alternative for the time being. Founders should therefore take a close look at how long their liquid assets will last and not count on further financing at attractive conditions.