“Be greedy when others are fearful.”
Venture capitalists in today’s climate remain hopeful to invest in companies that could adopt the adage.
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Outsized returns from companies often come from businesses that are able to fundamentally change and improve consumer behavior, especially during times of hardship. While COVID-19 has adversely impacted the global tech ecosystem, it has also shifted the market landscape and left pockets of opportunity that startups can disrupt. Here is why the next generational-defining technology companies may come out of this crisis.
A historical analysis of the top VC-backed exits by vintage year shows that value generated from these rare market shifts outweigh recessionary forces. I took all the IPO/M&A deals that exceeded $1 billion (what we define as an outsized return) and plotted the aggregate exit value based on the company-founded year.
During the 2007-2010 time period, the mass adoption of smartphones enabled a whole new set of consumer mobile interactions and allowed entirely new products/services to build on top of this platform (i.e. on demand, mobile web, etc.).
We can see that some of the largest venture-backed exits such as Uber and Spotify were born out of the mobile revolution. Interestingly, these elevated exit values coincided with the 2007-2009 financial crisis, which suggests that recessionary forces had little impact on exit outcomes. In fact, the 2009 cohort of unicorns had the highest aggregate value of exits despite being on the tail end of the recession.
Analogous to 2007, today’s preventative measures to contain the virus have created a market shift. Brick-and-mortar interactions have dropped precipitously and online purchases have skyrocketed. A study by Paysafe details that globally, 18 percent of consumers are now purchasing online for the first time because of their inability to access physical retail channels.
This influx of new customers allows founders starting online companies to introduce new innovations with lower CAC, increased repeated usage, and higher customer lifetime values. Products that consumers have not tried before are more likely to work today because government lockdowns have introduced a forcing mechanism for people to adopt new behavior.
New telemedicine platforms, for example, are seeing surging demand now that non-emergency visits to physical clinics are closed. Given that social interaction has been limited, social networking apps that had previously not appealed to older generations now have seen popularity with new demographics. This accelerated adoption across sectors such as food delivery, telemedicine and e-commerce will drive a sustained change in consumer behavior long after we move on from COVID-19.
While some founders may win big, are investors able to capture value during tough times?
Consistent with company returns, an analysis of venture fund performance by vintage year shows that top funds like A16Z or Lowercase Capital, that started during or slightly after the recession, actually performed better than peers in prior vintage years.
Both the median IRR and TVPI from 2007 onwards were significantly higher than prior years. This can be a function of higher exit outcomes and/or lower valuation prices, but are likely more attributed to the former given that these elevated returns continued throughout the last decade–long after the recession.
In addition, funds that started prior to the recession but had enough dry powder to ride the wave up also benefited greatly. A good example of this is Founders Fund II, which raised in 2007 right before the financial crisis but had benefited from investing in Spotify’s Series C round in early 2010.
For many founders, their market has jumped several years ahead; they are a few steps closer to the coveted unicorn status. Investors scramble to figure out which companies will continue to see sustained growth post-lockdown versus those that will snap back to more modest metrics.
As history shows us: Bear market, bull market, there will continue to be winners.
Written by Charles Yu, a principal at Bling Capital, and the founder of his own angel fund. Formerly an LP at TI Platform Management, Yu’s portfolio includes investments in consumer companies including Spotify, Lyft, Airbnb, Zocdoc, Pinterest and Flipkart.
Illustration: Dom Guzman