Dealing with Investors in this Black Swan Event
People are describing the COVID-19 pandemic as a black swan event. They talk like we know what a black swan event is. I looked it up.
The phrase comes from a time when black swans were thought not to exist so seeing one was a rare event.
According to Nassim Nicholas Taleb's 2007 book, The Black Swan, a black swan event has 3 attributes:
First, it is an outlier, as it lies outside the realm of regular expectations because nothing in the past can convincingly point to its possibility.
Second, it carries an extreme 'impact'.
Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.
As the Founder and CEO of an early-stage company, your world has changed almost overnight. You've done everything right to get to this point and something completely out of your control fundamentally changes your world.
Now, everything has changed. You’re no longer playing for your next round: you’re playing for survival.
The initial reaction can be fear, frustration, confusion, helplessness, depression, and anger.
It's very easy just to do nothing.
But you know that isn't really an option. If you can't adjust, you will fail.
So what can you do?
As Andy Grove, former CEO of Intel, stated when describing what happens to businesses in tumultuous times: "Bad companies are destroyed by crisis. Good companies survive them. Great companies are improved by them."
Here are some ways to use this situation to make your company a great company.
Manage Yourself First
You have to take care of yourself so you can take care of everyone else. It's essentially putting your oxygen mask on an airplane first so you can help the others. You need to take care of yourself both mentally and physically.
Now is the time to work with CEO Coaches or Advisors who have been through downturns in the past, like in 2001 and 2008. They can help you and guide you through what you need to do to survive. They can help with the mental discipline needed to get through this period.
Get exercise as much as you can. Eat well, drink less alcohol. Sleep when you can. You may have already been waking up in the middle of the night and with this additional anxiety, it may be happening more frequently or for longer periods of time.
If this is happening to you, here are the important things to know:
This is totally normal! There is nothing wrong with you.
When you do wake during the night, don’t fight it. Allow yourself to do productive work. If you aren’t motivated to do productive work, do something soothing, like reading a book. I do sudoku puzzles. I hear it's better not to use your digital device for these things but since all my books and puzzles are digital I do the best I can.
Constant overcommunication will diminish surprises while helping to clear out roadblocks and cope with bad news. You need to do this with everybody: employees, customers, and investors.
Overcommunicating doesn’t mean communicating everything; it means communicating the right things effectively.
Whether it’s good news or bad news, don’t wait until the last minute to deliver it. If you break the ‘no surprises’ rule and you have to deliver bad news, come prepared with other possible solutions.
Dealing With Investors
It's always a good idea to maintain good communication with your investors so that when things go bad it's not the first time they've heard from you in a long time. If that's you, it's too late to do anything about it.
Investors are scrambling right now trying to communicate to their investors (limited partners) what is happening with their portfolios, and working with the portfolio companies directly on new operating plans.
One VC I know was on 7 emergency board meetings just this past weekend!
VCs are looking at their portfolio companies and making their own assessments on their survival rates. For investors, the crisis will divide their portfolio into two: companies that are likely to “survive” Coronavirus; and, those that probably will not.
An easy way VCs do an assessment is to model with 2 variables: how much sales will fall and how much operating expenses (OPEX) are cut. The adjustment starts with Q2 as Q1 is pretty much in the books now. There isn't going to be a big surge in sales at the end of the quarter, as usual, so whatever you have booked is what will make up your Q1 numbers.
Revenue decline assumptions will be anywhere from 15%/quarter to 20%/qtr. That largely depends on how long this shelter-in-place/lockdown/quarantine lasts. Speculation is that quarters 2 & 3 will be awful with any hope of uptick coming in Q4 2020 at the earliest.
OPEX cuts are modeled at anywhere from 15% to 50%. When you make cuts cut way deeper than you think you need to. Often first time CEOs and founders who have not been through downtimes like this fear "cutting into muscle." The fact of the matter is you seldom are and you probably can't cut deep enough.
Cut deep, do it quickly, and do it one time.
Here is how Sequoia models companies in their portfolio:
Feel free to use the same approach to your modeling.
Modeling is hard and whatever you come up with is likely to be wrong. But doing the work is necessary and you'll be better off for doing it. The act of planning is more useful than the plan itself.
With all this uncertainty the markets are in flux. Why buy today when it may be cheaper tomorrow?
There will be a decrease in valuations. The public market valuations are dropping dramatically and that puts a lot of pressure on private company valuations.
But there is still a lot of capital that needs to be invested and there is likely to be more money put into private companies. With interest rates close to 0% investors are always looking for asset classes that can deliver a higher return and private companies meet that criteria.
VCs are obligated to make good investments that generate good returns. But there are no commitments on the number of deals they do so there will be fewer deals done and they're likely to take longer, too.
Here are a couple of things I've heard from investors:
“I ABSOLUTELY am taking conference calls with companies. I would be interested in conference calls assuming they are at least $500 million in market cap unless they are a private company with really interesting technology.” Long fundamental Investor 30B AUM
“Thanks for reaching out. Family and I are doing well hope yours is too. Our firm is fully operational and would be more than happy to meet with companies that meet our spec. Appreciate you thinking of us during this time.” Public/Private Growth Investor 1.5B AUM
“I’m taking a pause on new deal meetings, at least for the next month, and am instead focused on clearing my desk and managing the portfolio. Happy to touch base on this again in late April, when I expect I should be in a much better position.” Healthcare Venture Investor 30B AUM
“Our firm is in the assess -our-own-portfolio category right now, and my best guess is that it will be at least two months (maybe more before we resume looking at new opportunities.” Healthcare Family Office 350M AUM
“There is uncertainty in customer outlook, and that makes it challenging to assess current business traction, progress, and momentum – all of which are critical inputs to establishing valuations. Also, many investors need to meet prospective company teams in person and visit the company on-site. In-person meetings help build rapport and cement the relationship. That said, we do think that after an initial meeting or two, it is much easier to continue the relationship via video meetings, so there may be much more opportunity for deals that are in-progress to get over the finish line.”
Cybersecurity Venture Investor 300M AUM
It's a mixed bag and largely depends on the investor. It's widely believed that most deals that are in-process are likely to close. But not all of them. Some investors are pulling out of deals they've committed to leaving the founders high and dry.
Jen Edmon, Founder of Event Hollow, a client of mine, has been working on closing a $500k seed round for her company for months. She finally got everyone committed and just before funding one of the investors, FoundersPad, backed out. Thankfully the other investors rallied around the founder, made their investments as they committed, and are helping to find a new investor.
As disappointing and heartbreaking as that was for the founder, at least she found out what the firm is like now and didn't have to learn at some point in the future that the firm would not support her in bad times. It's a blessing in disguise.
Financing Terms Will Change
In addition to valuations dropping, the terms are likely to change also. In 2001 investors were asking for, and getting, 2x liquidation preference AND participating. That means the VC not only gets 2x the investment back off the top, but she also gets to convert her preferred shares into common and participate in any leftover proceeds as with any other shareholder.
That sucks for the founder. Double-dipping like that is pretty unusual now but they weren't in 2001. The goal is to survive so you take the money and move on.
In 2008 Box completed a $6 MM Series B financing at $18.95 MM post-money valuation. Then the financial crisis hit. Box was lucky enough to complete another $7.11 MM financing as an extension of the Series B, resulting in a $26.06 MM post-money valuation. It didn't have to do a down-round but it did give 50% ownership to the Series B investors. One year later, when the economy started to improve, it was able to $18 MM Series C round at a $69.2 MM post-money valuation. It survived and is now a public company with a market cap of $1.9 billion.
There are a number of companies that were created in the 2008-2010 recession include Uber, Airbnb, Slack, Pinterest, WhatsApp, Square, and Venmo. No doubt some of the most iconic companies of the next decade will be launched during these surreal times.
Emanuel Rahm stated, "Never let a good crisis go to waste."
I don't mean to be flippant or to be dismissive about the effects of COVID-19. It is terrible and people will die. But it will end, hopefully soon.
If you're raising money now don't give up on your dream. It may take longer but look for investors that can see your vision for how the world will look in 12 months.
Think ahead and work backward. Maybe push your milestones out from 6 to 18 months. Create a story around that and create a plan for how you will get there.
Be disciplined, adjust, take money at a lower valuation and with unpleasant terms. Live to fight another day. Your #1 job now is survival.
Let go of what has been normal for the last 7 years or so. Focus on building a great company.
All your stakeholders are looking for you to step up and lead them through this crisis. It is going to be really hard. Whatever the outcome for your startup, you will be a stronger and more capable leader.
So for you, where should a re-evaluation of fundraising and building your business fit in your newly forming priorities? The answer will be different for different businesses. But the question must be asked. To help you figure out the answer for YOUR business, let’s schedule a quick 15 to 20-minute chat. That will be long enough to ask and answer a few key questions. This is critical as you determine, "What's most important NOW?”
You can reach me at firstname.lastname@example.org or you can schedule a call with me here: https://calendly.com/mikerogerstrg/startup-growth-breakout-session
Feel free to also visit our website to learn more about the services we offer to help you Position Your Potential: https://www.therevenuegroup.net/.
I also invite you to download our Pitch Deck Outline that lays out for you what should be in your deck, in what order, and most importantly why by texting "Startup" to 66866.