The COVID-19 crisis has changed the lives of billions of people on Earth — including a small subset thereof, that is VCs and entrepreneurs. The change is not always positive or pleasant — but it's certainly here to stay, and it's very important to understand how to adjust for it.
In a recent podcast episode, we discussed what the crisis means for European venture capitalists with Fred Destin, co-founder of Stride.VC. The firm invests in startups in France and the UK across all verticals and helps them enter the US market.
An industry veteran, Destin started his career at J.P. Morgan and Goldman Sachs. Over the past 20 years, he’s worked as a partner at Speed Ventures, Atlas Venture (now Accomplice), Accel, and more.
“I've been doing this since '99,” Destin said. “So in the days of the great bubble, I jumped into seed investing and just learned on the job.”
This is the second part of our interview with Destin, where we talk about Stride VC itself and the way things have changed for the firm with the coronavirus outbreak.
Make sure to also check out the first part, where we discussed the function of VC in times of crisis.
The interview has been edited for clarity and brevity.
Q: The COVID-19 crisis has brought a lot of changes for startups. But what has changed for the VCs like yourself?
I'm not certain that anything's changed in the way VCs operate. What I think is very clear right now is that we are faced with a crisis of unknown length and unknown depth.
One of the things you care about with startups is at what level can they exit and how much you earn when they do — that's your primary determinant of return. But the path to getting there is a path of refinancing and multiple rounds, which depends on how efficiently you use your capital. Right now, you don't know when you're going to get refinance, at what valuations, and whether the capital markets are going to be open. That's an awful lot of uncertainty in the pathway towards an exit.
I don't think the long-term prospects of a lot of our companies are impacted. However, how much time it takes, how many financing rounds we need to go through, and how hard these financing rounds are going to be from a valuation standpoint is less certain.
I think people have fundamentally reassessed the risk appetite, which is very logical.
At the same time, the general view in the industry is that the “venture vintage” of 2020—2021 should actually be really good because of lower valuations and more capital-efficient companies. This is a great time to invest.
The issue is that in the US, for example, the statistic for seed funds was that their companies had six to 12 months of cash on average. So, there are people with large portfolios — that is, seed funds that have done 50 to 60 deals — that see that up to 50 percent of their companies have less than six months of cash runway.
That means your house is on fire. There's a number of your teams that didn't get funded before the lockdowns, and they're going into a capital market that's making decisions much more slowly and has become much more selective. And you are forced, no matter how much you love your founders, to be a portfolio manager and to do what's called triage, which is a word I fundamentally dislike. But the reality is that people are sort of trying to pick amongst their children — which ones are going to survive and which ones they need to let go.
I don't want to be overly negative. Failure of a startup — while it is not a happy event and people lose their jobs — is not the end of the world in the sense that people get recycled within the tech ecosystem fairly quickly.
We see that vacancies in tech startups in London, for example, are still pretty high. Companies go bust, teams get reintegrated, people start something new two years later — and we have the benefit of these small, agile organisms that evolve all the time.
Right now, a lot of the companies are learning from lessons of the past and saying they'd make hard cuts early, maybe cut even deeper than they think is necessary, because they don't know yet how bad the crisis is going to be. I think that a lot of people are hitting the brakes, but hoping that they can start rehiring and regrowing the team on the way out.
Q: So, what does it mean for you? Do you focus on your portfolio companies now or are you still looking for new deals?
When the crisis hit, I looked at all the data to the extent that I could, and I realised this was going to be worse than 2001—2003, with structural damage to the economy and this complete unknown on how and when you could hope to return to normal. I decided at the time that I'm just not smart enough to process all that information, I don't have a mental model that allows me to deal with this.
With too much information coming in too fast every week and our number one obligation being to take care of our portfolio, we decided to go on hold.
We're probably the only VC in Europe to just say that we're not investing right now. It allowed us to be fully focused on our startups. What we try to do with them is not just look at the runway and the budget, but actually go one level deeper and think — how do we reposition, for example, marketing and sales messages and the way we talk about the product in the face of COVID-19.
We're slowly re-engaging now: we have started to look at investments, we've even already made one, post-COVID, which is closing soon.
One of the things that I smile at is how everybody's analysing the thematics that are going to work well through the crisis — and everybody comes up with exactly the same themes, like remote work and all that stuff. Of course, if you're trying to fund remote work, there will be opportunities. But in reality, you should be a late-stage fund, already having identified the assets that are going to scale and dominate, and you should be funding something like Notion or the next Zoom alternative.
For us as seed investors, these are not new themes. These are 10-year-old themes that are now gathering steam and scale, so we have to look beyond that at things that are less obvious rather than plunk money into online groceries and remote work.
Q: Have you been able to avoid the dreaded triage for your portfolio so far?
We were lucky, but I have to say that VCs will sing a different song depending on where they're at.
Let's say you're Index or Accel, you raise €500 to €600 million funds, vastly oversubscribed — in this case, it's relatively easy for these funds to support their portfolio because they have so much market power and so much dry powder.
If you're a first-time seed fund at the last 10 percent of your investment cycle, and you've backed 30 to 40 companies in the last two years when the market was hot — you’ve got a problem.
First, you've got a valuation problem, because a lot of these companies are probably fairly highly valued. Second, you've got a funding problem, because you probably have a bunch of hungry mouths that you need to feed.
In our case, we have done 10 investments, and eight of the 10 are funded into 2022 — through a mixture of luck and preparation, I suppose. One company is funded into mid-2021, and only one is fundraising now.
There are a few companies in our portfolio that we are massive believers in, which are doing really well. So, we did something that's not really part of our strategy: we just doubled down into them.
We immediately went to see the management and said, do you want a couple more millions to buy yourselves some runway? These were very quick transactions done internally — but really on our best performers.
Through a mixture of luck and preparation, we're actually in a good spot. But my heart goes out to the managers who are at the end of the fund cycle with a lot of highly-priced companies — it must be a tough time.
And by the way, the problems get worse as the companies get more scaled up. It's much easier to manage issues of burn and revenue decrease when you're a seed company; if you're a Series B company that's just moved from 40 people to 80 people, and your success is predicated on doubling or tripling your revenues this year — that's tough. Now, if you're a 500-person company whose revenues might go down 30 percent this year, that's really, really hard to manage.
I went through this in 2002—2003, and it is soul-destroying to have to do a layoff after a layoff. I remember one company that had revenues of $25 million in 2001, $20 million in 2002, and it dropped to $15 million in 2003. And it's a good company, we ended up setting it quite successfully. It was just a long journey — and a quite lonely one for the CEO.
To be continued…