The COVID-19 pandemic has caused a massive wave or uncertainty in the venture capital (VC) industry. With practically everything now on pause, both startups and investors have been launched into a state of uneasiness, and we are seeing the consequences across industries.
Kenny Estes, CEO of Diffuse, talks about how the pandemic is causing “weird market anomalies”, where “things that shouldn’t be correlated, or should be inversely correlated are against each other, and people are just panicking”. In a recent survey, a number of investors said that the COVID-19 crisis will have a negative impact on the early-stage investing industry for up to two years.
As a result, investors are selling their shares for significantly less than the original purchase price. Here, Kenny explains why.
Why investors are selling their shares for less
VCs typically have one to three years where they’re actively putting money out of a fund, according to Kenny. Within those three years, VCs start from smaller funds and gradually work their way up to raising larger and larger funds eventually. However, those fundraisings are not happening right now, Kenny notes. VCs are finding it difficult to fundraise in this environment and consequently, everything is on hold.
While VCs and startups are suffering from the outbreak, Kenny says investors are experiencing the same cash crunch as the rest of the market is. Therefore, if startups are in a distressed position right now, their investors are going to rush to get out of their ownership as soon as possible.
“Across the board, everybody’s pulling back and trying to get as much money into cash, with the expectation that it’s gonna be safer if things go sideways,” Kenny explains. Investors who are willing to sell their shares at a discount are usually co-investors, and typically they are trying to sell their shares to lead investors, Kenny added.
How investors are taking advantage of discounted ownerships
For lead investors, the predicament causes a unique opportunity where they are able to increase their position in some of the companies that they’ve had longer relationships with because of these discounted shares.
Right now, private equity and VC firms are going to their LPs and convincing them that “‘we can increase our position after having had a two year relationship with them, and actually come in at a lower cost basis than our original check,’” Kenny shares. “That’s actually something you can potentially convince people of.”
Private equity firms and VCs also have the option to do tender offers or similar deals where they offer to buy investors’ shares back after a certain time period, but the reality is that those deals do not happen very often. Kenny says that investment firms would rather go around to convince investors of a strategically more solid deal. “‘Hey, here’s this opportunity. Here’s something that we can do. If any of you hear anybody who is looking for someone like us, just put us in touch,’” and startup founders are more than willing to facilitate that, Kenny explains.
“When you get into bed with a VC, it really is a marriage. You’re going to be working with them as a startup, or vice versa, and VCs typically work with the founders for 7 to 10 years,” Kenny says. As companies come under financial pressure now, investors are called upon to come to their aid for survival.
The Principles for Responsible Investment advised investors internationally to take such responsibility, and recommended several immediate actions in response to the current situation. One of them is to “be receptive to requests for financial support.” Where feasible, the PRI called on investors to consider granting “as much grace as possible in order to assist in a coordinated economy-wide response and recovery.”
Investors are also saying that now might be the best time to reevaluate operations to reduce costs, and to prioritize closing any open deals in the short term.
Here at Diffuse, we take care of our investors as much as we care for our startups. If your organization is in distress, or you want to seek startups offering great equity opportunities, feel free to reach out to us at [email protected].