Venture investing in a downturn
Alternative asset classes are reliable hedges to protect wealth amid downturns, volatile markets
As the United States’ economic expansion became in 2019 the longest-recorded run, and the stock market kept reaching impressive new highs, there were more and more news headlines and discussion on an inevitable recession/correction.
Although we could not predict the timing, the cause, or the severity of a downturn, in every meeting with investors, we always highlighted the importance of building a diversified portfolio with an allocation in private equity or venture capital. Given the low correlation with the liquid markets and the focus on long-term value creation, private equity and venture capital are reliable hedges to protect investors’ wealth amid an economic downturn and a highly volatile market environment.
While each economic downturn manifests itself in unique ways, this crisis feels unprecedented, given the speed and scope at which the COVID-19 pandemic has swept the globe.
The severe political, social and economic uncertainties have pushed the S&P 500 into a bear market in just 16 days, the fastest time period on record. The financial and market displacement has prompted our investors to reach out to us, concerning how they should adjust their portfolio allocation, as well as how they can take advantage of rising opportunities.
As a result, we are offering a new debt vehicle — venture debt — to offer our investors a fixed-income investment with high yields and managed risk. We will follow up with a white paper on venture debt, regarding the structure and investment rationale for anyone who is interested.
For venture capital specifically, the COVID-19 crisis presents both opportunities and risks. Over the last decade, the capital abundance in the private market has pushed company valuations to an elevated level and encouraged the practice of growth at all costs. An expected slowdown in VC funding will result in lower valuations and will force founders to do more with less. We welcome this shift as it allows us to invest in high-quality companies at reasonable prices. In addition to better investment choices, the current situation also gives us the leverage to negotiate favorable structured terms to help protect our investors should the uncertain macro environment persist, as well as to enhance the investment return.
From a longer-term perspective, the current environment with digital connectivity taking even more of a hold on everyday habits, created a strong tailwind for our technology companies. In fact, COVID-19 is an unforeseen catalyst for fast-track, long-term tech adoption as people have greater motivations and fewer perceived barriers to try new technology, tools, and softwares to help them adapt to their new lifestyles.
While we keep an eye on new opportunities, as well as emerging trends that potentially benefit the fund and the portfolio companies, we have also focused our efforts in managing the implications of the virus outbreak on the portfolio companies and assessing the risk level of the entire fund.
Our leadership team has reached out to our founders to help them map out contingency plans to weather this storm. The discussions ranged from stabilizing current operations, to cutting down expenses, engaging with customers, ensuring higher ROIs on marketing spend, and preparing for recovery and growth, etc. Depending on the industry sector in which a portfolio company operates and the business model that the company follows, some companies are more affected than others.
Given the massive pull back in consumer activity, and the nature of the pandemic keeping people at home, companies in the mobility and music-tech verticals have experienced a more significant drop in demand compared to companies in fintech and big data, which are selling software or data to enterprises. On the other hand, companies in foodtech and telepresence tech have gained traction since they provide a solution for people to adapt to the changes due to the COVID-19 crisis.
Yet revenue vulnerability only shows one dimension of risk.
The other risk dimension is cash runway or liquidity. Facing the uncertainties of COVID-19, we recommend that every founder should aim for 6 months of runway but in fact the longer the runway a company has, the better position it is in right now to embrace the evolving challenges. With a cash runway on the y-axis, and revenue vulnerability on the x-axis, we created a portfolio heat map, which is broken down into four quadrants.
Quadrant I is for the companies that are less affected by the pandemic shutdown due to the nature of the business and also have enough capital to navigate the uncharted waters of COVID-19. In contrast, quadrant III is for the concerning startups who saw their toplines drop substantially but don’t have enough cash to weather this storm.
From the fund perspective, to have a complete and accurate view of risk, we added to the chart the size of the investment in each portfolio company which is measured by the size of the bubble. The chart also helps the fund decide where best to allocate time and resources since we want to make sure that our big bets are protected.
This post was authored by Fuel Venture Capital General Partner and Chief Investment Officer Maggie Vo, CFA. Maggie manages investment activities, leads due diligence for prospective investments, and performs valuation analysis for existing portfolio companies. To reach Maggie, email her at maggie@fuelventurecapital.com. Follow Fuel Venture Capital on social media, via Instagram, Twitter and LinkedIn.
Disclosure
Information provided in this paper is for educational and illustrative purposes only. The material presented represents the opinions of Fuel Venture Capital, as of the date of this report. The information and opinions presented have been obtained or derived from sources believed to be reliable; however, the accuracy and completeness of such information expressed herein cannot be guaranteed. Opinions are subject to change without notice, and Fuel Venture Capital assumes no responsibility to update or amend any information or opinions contained herein. Keep in mind that past performance is not indicative of future results, and there can be no assurance that the Fund will achieve comparable results, achieve its investment objective, implement its investment strategy or avoid losses.
Nothing set forth herein shall constitute an offer to sell any securities or constitute a solicitation of an offer to purchase any securities or any other product sponsored or advised by Fuel Venture Capital or its affiliates, nor does it constitute an offer or a solicitation to otherwise provide investment advisory services. Any such offer to sell or solicitation of an offer to purchase shall be made only by formal offering documents, which include, among others, a confidential offering memorandum, limited partnership agreement and related subscription documents. Such formal offering documents contain additional information not set forth herein, including information regarding certain risks
of investing, which is material to any decision to invest. Performance data presented herein is provided for illustrative purposes only, is not indicative of future returns and is no guarantee of future results. Investments of the type described herein may involve a high degree of risk and the value of such instruments may be highly volatile. Investors may lose some or all of their investment. This brief statement does not disclose all of the significant aspects/ risks in connection with investments of the types set forth herein, including relevant risk factors and any legal, tax, and accounting considerations applicable to them.
