Few years back I had no idea about how investing works. In 2012, when I was first toying with the idea of becoming an entrepreneur I did not even have a clue how venture investing works. Then I got a chance to run an accelerator for early stage Fintech start-ups for some time with investment ticket size between 100k to 250K USD. I was closely involved with the entire process right from application, selection, investing to advising and helping them on various aspects of their business. While that entire stint was good fun, it also gave me a chance to interact with many start-ups from across the globe and opened my perspective towards appreciating and entrepreneur’s world and his/her perspective. If I was still doing early stage investing, how would I approach the current situation or should I use the word opportunity.
In my opinion this is the best time for early stage investors from deal making point of view for the simple fact that the nature is helping their selection process. The start-ups that are being built right now are primarily the ones where founders believe in their idea and execution ability beyond any reasonable doubt. Founders who were getting into business with the belief on their fund raising ability would be thinking of backing out now. That’s one big plus for any early stage investing.
Second big plus is that these start-ups are starting from rock bottom, if you and they believe that can make it in this situation, there is a huge possibility that things will only get better going ahead. If one can make it work given the current constraints and planning keeping the new world order and new learning in mind, it will be better for them to sail through than someone else who started earlier in earlier world order and now finding themselves back on the drawing board trying to figure out how to re-calibrate their products and processes. Some of the things which looked like a good thing to do 4 months back may feel like a huge inefficiency in the system. Very simple example would be if someone spent in an office lease may find out that it would be more efficient to work with only 30% office capacity.
Third point in favor of my argument is the ability to structure the deal in your favour with valuation expectations of founders readjusted to the new world order. There will be lesser haggling on valuation and you may be able to hold same equity for lesser investment. So even though your ability to raise fresh fund will be impacted to some extent due to global recession caused by this crisis, you should still be able to hold same kind of portfolio by finding a more favourable deal structure. If buying at low is true for public market, same should be true for private market to a large extent.
Fourth and the most important point is that the cost of labour has gone down significantly. Most organizations have reduced salaries of their staff. Typical salary-cut is in start-up world is in the range of 30-50% that means availability of good resources at lower cost has improved. If staff cost was a significant part of your burn, imagine it going down by almost 30% without you doing anything on your part. Since keeping the cost structure lean is one key criteria for any early stage start-up, current situation provides every early stage start-up a great opportunity to do so. With burn getting significantly lower with lower costs, a start-up maybe happy raising lesser than their original plan and try to run it in much more cost effective manner.
A seed stage investor works on the principle of taking higher risk in order to reap higher rewards that simply means the if they invest in twenty start-ups, the expect one of them to become a unicorn and three a semicorn so that even if all others fail their net return is significantly on the higher side. So their worry is not about making an investment that might fail, their bigger worry is missing out on one that might succeed. The opportunity presented by this downturn is that they may not be able to make twenty investments now but only ten however the possibility of those ten succeeding now would be much higher and return much more rewarding.
There may be an impact on the start-ups ability to generate revenue but for an early stage start-up immediate revenue is never a key criteria, by the time they reach a stage in their plan where they should start generating revenue markets would have recovered and customer’s ability to consume would have been restored. So to conclude, this is the best time for early stage investors to make deals and given a choice they should not miss this opportunity. Don’t wait it out. Get busy with Zoom calls scouting the deals. In that stage even due diligence can be performed remotely. Do the deals. All the best.