How Covid has changed the funding landscape for startups

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VCs and founders give their views on the shifting importance of growth and profitability.

Lucy Ingham of Verdict Magazine spoke to the leaders of startups and venture capital (VC) firms from across the global tech community to ask how the funding market had changed and what founders could do to attract investment. This is an edited version of an article first published in August 2020 that contains insight and opinion that remains relevant in 2021.

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Rapid and continual growth has been important to many startup investors for some time. But such growth may impact on a business’s profitability. So how has this balance between growth and profit been changing – and what is the outlook for both founders and funders?

Growth, risk and startup investment

Amit Anand, co-founder and managing partner of Singapore’s Jungle Ventures, argues that while “growth is good and dare I say even essential to the success of startups… it is the growth-at-all-costs mindset that has led to some recent, spectacular failures.”

“There is a generation of founders who don't know anything about building a business that can last without having an unlimited supply of capital,” he says.

“Their measure of success has always been keeping up the growth through often practices oriented to the short-term. I feel that the failure of some high-profile, so-called ‘role model’, startups has drawn attention to these issues, but the events of the last few months have certainly exposed the fault lines completely, and rightfully so.”

Meanwhile, Olav Ostin, Managing Partner at venture capital firm TempoCap, believes that investors are going to place a greater focus on profitability in the future. However, he still sees growth as key.

“Personally, if a company can demonstrate that it can still grow in the current environment, then that is an incredibly powerful statement and a testament to their business and its viability,” he says.

“Companies that are still growing will attract investor appetite. Being able to show growth in adverse times is always attractive.”

A changing funding landscape

But growth can take many forms, and despite its lasting importance in startup funding, there is a sense that things are changing.

Arun Penmetsa, partner at Silicon Valley-based VC firm Storm Ventures, argues that while growth is certainly not dead, there is “more emphasis on building resiliency in an organisation and gaining a better understand of the risk factors.”

“In the short term, companies are focused on preserving cash given the uncertain state of the recovery and fundraising environment,” he says. “I think that focus will continue for a while. In the long term, growth is still vital, especially since public markets are still valuing growth.”

Stephen Page, founder and CEO of SFC Capital, sees the relative importance of growth and profitability as more unique to each company.

“At the heart of the matter I do not believe that any good investor will separate the two,” he says. “Almost every business will want to make a profit at some point. CEOs do not want to be constantly giving away more and more equity all the time. Investors will also not be interested in a company that constantly needs support through its life, they are looking to make a return.”

Accelerating a longer trend

While the coronavirus pandemic has shaped the funding landscape for startups, it may not be as strong a driver of change as it initially seems. Instead, many see the shift away from growth-at-all-costs to be rooted in an earlier time.

“We think the recent shift of focus from growth to profitability was underway before Covid-19 really hit,” says Matt Wichrowski, partner at European VC firm Fly Ventures.

“There have been a number of high-profile tech companies that have very publicly struggled to command the same multiples in the public markets. Those examples have had a significant impact in investment thinking, though that's much more pronounced in the later stages of venture.”

Kirsty Grant, chief investment officer at Seedrs, agrees with this sentiment, arguing that “a reckless pursuit of growth-at-all-costs has been out of fashion amongst investors for some time now,” adding that Covid-19 “has validated that approach.”

“As we’ve seen from our investor community, people continue to look for ambitious companies,” she says. “But as always, they want to see management teams that have sensible cash and resource management plans and the wherewithal and agility to pivot strategy quickly as circumstances unfold.”

Investors still have money

Amidst these changes, and the severe economic impact the pandemic has inflicted, it is important to note is that it hasn’t drained the accounts of investors.

Christopher Kong, co-founder of Better Nature, a food startup focused on plant-based meat alternatives, describes the last few years as “one the longest bull runs in human history,” arguing that investors are for the most part “sitting on piles of cash that they’ve managed to accumulate over a decade of continuous growth.”

“As a result, though the coronavirus has been and still is a massive disruptor for the vast majority of businesses, many VC firms are currently finding themselves in a position to be able to write massive cheques,“ he says. “However, they will only do so for the most promising startups that fit their new investment theses that are adapted to the post-Covid-19 world.”

Isabelle O’Keefe, principal of early stage VC fund Sure Valley Ventures, agrees, saying that VCs are “still investing, albeit a bit slower.”

“A lot of venture capital funds have recently raised $100m+ funds and have a lot of dry powder that they want to put to work and continue to be opportunistic,” she says.

Rebecca Burford, a corporate transactional specialist and partner at law firm Charles Russell Speechlys, also sees “dry powder” being plentiful, aided by the growing presence of government support, such as the Future Fund.

“Although there will undoubtedly be a recalibration of valuation multiples and a renewed emphasis on due diligence, investors still have large amounts of capital to deploy,” she says.

Different investors, different styles

While investors may be more choosy with their funding, there is not a one-size-fits-all response to the coronavirus pandemic when it comes to startup investors.

“Investors are engaging with potential fundraising in different ways. Some investors have put all of their new investments on hold to preserve cash to fund their portfolio companies if at all necessary,” says Justas Janauskas, co-founder and CEO at knowledge-sharing startup Qoorio.

“Other investors have increased the quantity of new investments, especially if they’re betting on a new normal. We’ve also seen some investors not changing their approach and behaviour at all.”

For startups looking to raise funds, what is key is the ability to stand out from the crowd.

“The great companies are still raising, and valuations are still very high, but I would say a company that is not exceptional and innovative will find it much more challenging to raise in this environment,” says TempoCap’s Ostin.

Increase your startup’s chance of investment

Despite all the cash that may be waiting to be claimed in investors’ bank accounts, the fact is that the coronavirus pandemic has ravaged some industries and seen others grow rapidly. In short, the economic landscape has changed, and the startup landscape is inevitably a part of that.

As a result, there are going to be shifts in investor priorities between industries, in much the same way that there have been changes in the profitability of certain verticals.

On the winners’ side, according to Jungle Ventures’ Anand, sits technology, thanks to the surge in remote working and the hurried scramble to embrace digitisation. And startups in this area are going to see improved investor interest.

“From being able to order essential supplies over online platforms to finding better productivity and work-life balance via work from home, these are all significant changes in behaviour, and startups are at the forefront of this tectonic shift,” he says.

“There is scope for tremendous organic growth. Industries and teams that balance this windfall whilst still maintaining good business practices – as there could be another crisis around the corner – are the ones that will emerge as once-in-a-lifetime value creators.”

TempoCap’s Ostin also sees technology doing better than other fields, arguing that “startups with virtual business models, ecommerce, cybersecurity, gaming” will be less severely impacted than others. However, he does argue that this alone will not make a startup immune to damage.

“A danger lies in being short-sighted and believing that just because a company is virtual means it won't face some difficulty in Q3 and Q4,” he says.

“The likelihood is that, in the medium term, the spending power of consumers will be adversely impacted, and all sectors must be prepared for these specific issues in the second half of 2020 and into 2021.”

And while all companies may be on shaky ground, some face a considerably more precarious time ahead with travel, hospitality and retail being widely identified as being at risk.

However, the story is not black and white; companies in these fields can succeed in testing times. As Ostin explains, while “there will be a significant learning curve for these businesses, those that are agile and innovative will be the most successful in the coming months and years.” SFC Capital’s Page echoes this sentiment, arguing that “good companies will still get funded, it will just take longer to convince investors.”

Advice for startups

For startups looking to successfully navigate these intensely rocky waters and attract much-wanted funding, investors have plentiful advice. And for many, this focuses on being adaptable to the changing reality that lies before us.

Fly Ventures’s Wichrowski warns that what lies ahead is a “very different market,” so paying close attention to meeting the changing needs of clients is key.

“In a recession client budgets will be frozen, corporate champions will be let go and contracts will be renegotiated, delayed or cancelled outright,” he says. “It's critical that you solve a top priority for your customers. New technology adoption in the enterprise will be significantly stunted unless a startup can deliver a clear, quick and/or significant ROI.”

Jungle Ventures’s Anand takes this idea of change further, arguing that founders need to “learn, adapt and guide change.”

“Ones that will be able to absorb information and act decisively will have an advantage as the next few years could be quite volatile,” he says. “The most successful businesses will also be those that have built teams that are aligned on a culture of collective good.”

For others, however, applying a sense of realism is also vital. While some radically ambitious startups will continue to attract funding, the most successful businesses are likely to be those that can demonstrate to investors that they will prove to be a profitable choice.

For Oliver Holle, managing partner of early stage specialist VC Speedinvest, this means that while the fundamentals – “great team, strong market and viable product” – remain the same, startups need to be “realistic with their outlooks.”

“The more you can prove your business case and help demonstrate a not-too-distant path to profitability (or at least healthy gross margins) the better chances of receiving the funding you need,” he says. “Plan for the worst-case scenario and try to maximise your runway. Investors will appreciate your efforts to adapt to the current market situation.”

This sense of value for money also extends to how startups are operating. Notion VC’s White argues that demonstrating that you are being careful with money is key to showing investors your company is worthwhile.

“My two pieces of advice to startups looking for investment during this time – and beyond – is firstly to ensure you’re thinking at least as much about efficiency as you are about growth, and secondly, ensure your product, whether you are B2B or B2C, is lovable – and that it perhaps doesn’t rely too heavily on in-person contact!” he says.

This sense of caution also extends to startups’ approach to fundraising itself. Fintech startup Yapily, which raised £13m in a Series A funding round shortly before the lockdown, advises making use of fundraising when it is an option, rather than turning to it when it is urgently needed.

“The financial impact of coronavirus will be felt by both investors and entrepreneurs. Startups need to maximise chances of success rather than chasing a valuation,” says Stefano Vaccino, CEO of Yapily.

“This means raising when they can, not when they need to. Because you never know what’s around the corner or what could happen in the future.”

However, growth is still an ever-present part of the challenge, with Better Nature’s Kong arguing that it remains a priority. “In a world where large corporates still dominate many industries, the lack of growth is synonymous with death,” he says.

“The mantra ‘monopolise or die’ still reigns and startups must focus on building a monopoly or face being outcompeted by their peers or larger incumbents.”

Startups are vital to recovery

For startups struggling to establish and grow amid such chaotic times, the road ahead may look daunting. However, many investors see such companies as well-suited to making the most of the current disruption.

“The nature of startups is to solve a problem with a tech solution that is scalable and can address large markets, so challenging times present opportunities, particularly for tech entrepreneurs,” says Sure Valley Ventures’ O’Keefe.

“The last few weeks have shown us that there is rapid adoption of online and digital services and a shift in spending. It is unlikely that many of these trends will be reversed after the pandemic and so this poses the right environment for tech startups to succeed.”

For investors, meanwhile, this may also prove challenging, but there is promise ahead.

“Investing in startups has always been for the patient investor,” says Seedrs’s Grant. “When there is turmoil elsewhere in the public markets and low interest rates, early stage investment often sees new interest pour in.”

“We are seeing downward pressure on valuations as investors are, rightfully, expecting a longer and potentially bumpier road to exit, but we are still seeing strong and growing interest in the asset class.”

Summary of insights and opinions

  • Growth is always important but is not be the only consideration for investors
  • Profitability can become more important when funding is less available
  • Investors paid more attention to resilience and risk management in 2020
  • Management teams that can manage cash and resources attract investment
  • Profitability will become more important in industries impacted by Covid, such as travel
  • Previous years of growth mean that many investors still have cash for the right startup
  • In tough financial times startups need to be solving a top priority for clients
  • Consider seeking funding when it is available rather than waiting until it is essential

The information contained in this article is correct at the time of publishing. We recommend that you carry out your own independent research before you make any decisions that will impact your business.

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