Smart money: What Aussie VCs will be investing in after COVID-19

Some business analysts will have you believe that right now is the worst time to be investing in early-stage businesses. Is this data manipulation or a lack of understanding of the sector?

There are many statistics and reports on what has happened during the COVID crisis, along with predictions of what is coming. The one statistic that causes me most concern is this: reports that the venture capital community is falling off a cliff because the number of investments has declined by 75%.

The narrative is the Australian startup community is going to be decimated because of COVID-19. 

It’s a compelling headline, but it shows a naïve understanding of the opportunity with emerging companies. I am not suggesting for one minute that the whole startup community will continue thriving under these conditions as it has in the previous seven years. It will be affected significantly, like any other sector. 

But what most investors don’t see is the breadth and depth to this sector. Instead, what is portrayed is largely focused on early-stage deals.  

The big secret is that now is a great time to be investing in emerging companies, and the smart money has moved from early-stage investing to investing in scale-ups.

The biggest retreat will be felt in the seed funding to Series A stage of a business’ cycle. And this part of the startup lifecycle is where a majority of VCs in Australia seem to focus. 

My conclusion is that the speculative deals (those based on instinct rather than solid fundamentals) are not being made and VCs are simply getting more focused on smart money. Most fund mandates provide this flexibility and the capital has already been allocated, so it needs to be distributed. It will be distributed but in fewer deals, and in deals that are much more mature and that are showing solid business fundamentals.

Time to reset

What a crisis highlights is a pause and calibration in decision-making; a fresh look at what is working and what is not working, rather than looking over our shoulder at competitors.

 VCs have dialed back the speculation and are focussed on deals that indicate:

• a strong likelihood to take off when the economy kicks back up;
• increasing revenue and market traction growth during this time; and
• deals that require follow-on investment to get through that next development gate.

I would estimate startups that fit these criteria make up about 20-30% of the total startup sector at any one time. We will now see a market calibration and refocus that should have happened anyway, but in good times we look at all the shiny new objects and spread the risk around much more.

The broader issue here is that when a ‘typical’ investor hears startup, they think of a small team, working out of a garage trying to fight their way into existence (and making enough money to keep beers in the fridge). The startup sector has a lot more depth than that. 

Contrary to some reports, deals will still happen. Money will still be invested, but it will be invested in the early-stage businesses that have:

• great fundamentals; 
• founders who have proven resilience; 
• a solid exit strategy; 
• crisis-resilient business models; and are
• ready to scale now, or when the economy recovers.

I believe there is no better time to be investing in this sector, but investing in the right part of it. Now is the time truly disruptive startups and scale-ups will begin to show up. 

Many of these companies find themselves at the intersection of opportunity, where they are ready to scale, or have traction and are deep in a multi-year commercialisation cycle. 

Is it a time to be angel investing on unproven technology and founders? There may be one or two, but largely no. 

Is it a time to shift the focus of your portfolio to investing in early-stage, high-growth businesses a little further down the track? Absolutely. 

Is it a time for sophisticated investors who are retreating from the mainstream capital markets to invest money into the scale-up part of this sector? I believe the answer is a resounding yes. 

This is where the smart money is going at this time, and this is where success will be, both during this economic crisis and as the global economy kicks back up. 

When we look back to 2008 this is exactly where the smart money went. 

AirBnB began in 2007 and by August of 2008, had developed the business model to the point where it was ready to scale. The GFC happened to be the perfect storm for the business model, and the rest is history.

The notion that investing experts are battening down the hatches and waiting for the storm to pass does not appear to be true.

The smart money during COVID-19, and as the global economy restarts, will be in those businesses that are ready to scale. We saw it during the GFC and we will see it again as we move through this crisis and beyond.

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