When VAST Data hit the hallmark of this era's Silicon Valley start-up boom last month, a $1 billion so-called unicorn valuation, it didn't come through a perfect pitch delivered in a venture capital firm's conference room. Face-to-face interactions typically considered crucial to VC transactions have moved online as Covid-19 spreads, but for VAST the virtual meetings weren't deal breakers.
"In some regards, it was just like closing Series A and Series B before," said CEO Renen Hallak. "It would have before been done face-to-face, but now we aren't able to, so we did most of it by videoconference call."
Part of VAST's recipe for unicorn success in a pandemic could be the nature of its business. The data-storage start-up counts the life sciences sector among its customers, including the National Institutes of Health. It's an example of a deal getting done amid an unprecedented economic crisis that speaks to the ways in which the VC and IPO market are attempting to navigate the coronavirus and plan for what could be a very different investing future.
The IPO market has ground to a near halt in recent weeks, but deals completed before the economic shutdown in March can make the year-to-date numbers look better than expected. According to Renaissance Capital, the 28 IPOs conducted this year represent a 17.6% decline year-over-year: total proceeds of $7.2 billion compared to nearly $9.6 billion by the end of April 2019.
Among those 28, real estate finance company Velocity Financial was one of the first to list and has since delivered a disappointing performance. Casper Sleep made its lackluster debut in February, and biotech Imara began trading on the Nasdaq the morning after the WHO declared a global pandemic in mid-March.
But the IPO window has snapped shut for now, and the last time start-ups hoping to go public faced a situation like this was the financial crisis of 2008, where deal flow ended down 85% from the year before. The financial troubles then were different from those today, business-made, as Treasury Secretary Steven Mnuchin said on "Squawk Box" last week. "This was not bad business decisions [sic] like in the financial crisis. This was not over-leveraged real estate."
A similar global event in 2003 did rattle the IPO market, though: SARS. While the financial ecosystem was still recuperating from the dot-com boom and bust, the SARS epidemic reached its peak around the world, prompting a 10% drop in the S&P 500 from January until mid-March. Once the CDC pronounced the U.S. outbreak contained in early May, the stock market began to recover, finishing up over 26% for the year. The deals dropped to 68, from an already light 70, while the proceeds dropped to $15.2 billion, from $23.7 billion, a decline of almost 36%.
A big difference between 2003 and 2020: At the time of SARS, investors were still wary after being burned by the tech bubble's burst. Investors entered 2020 with an optimistic outlook for IPOs, expecting a build on 2019's strong momentum. There were disappointments last year, such as WeWork's collapse and the disappointing Uber and Lyft debuts. But in all, the wide-open IPO window of 2019 did not appear to be closing before the coronavirus hit.
Yet the global health landscape today appears much grimmer than it did in 2003. By this time in 2003, global cases were below 10,000 and there were no U.S. deaths reported. More people have died from Covid-19 in New York alone than from SARS across the globe. After the SARS outbreak subsided, the IPO market bounced back, with deals jumping over 300% in 2004.
"If we are able to contain the spread of the coronavirus and get the economy moving forward, we could see a fairly robust IPO market in late summer," Nelson Griggs, Nasdaq president, recently told CNBC via email.
"IPO activity by private companies was quick to dry up in tandem with the volatility spike in the public market," says venture capital analyst Cameron Stanfill of PitchBook. "On the other hand, VC dealmaking, even within large late-stage deals, has been relatively unshaken."
Alan Patricof, co-founder of venture capital firm Greycroft, told CNBC some of the best private deals will be done during this period, "when the opportunity is there and the capital is still there, and you can be a little bit more selective. There is so much capital still."
As investors raise the bar for potential investments, Lead Edge Capital founding and managing partner Mitchell Green is looking at opportunities in cyber security and collaboration platforms across workflow, chat, and video communications.
Ambar Bhattacharyya, managing director at Maverick Ventures, likes consumer tech, deep science and digital health right now but is wary when it comes to hardware. Patricof suggests caution when surveying investments in anything related to advertising, while he, Bhattacharyya, and Lead Edge Capital's Green all expect retail and travel start-ups to be hard hit.
Regardless of the sector or what's to come in a post-Covid world, Patricof says companies looking to raise funds in today's market should follow one piece of advice: Get the money.
Renewed investor caution could spell uncertainty and disappointment for growing start-ups. "You can't have a public market down 30% and have private valuations not be less," Patricof said, adding that if companies have an investor they know and are confident will close, "certainty is worth a discount."
Valuations are key for companies looking to raise capital. If a company needs money, Green says, "it will be tougher to command premium valuations in this environment."
High valuations are still possible among companies that are executing well and enabled during this time, but Green says, "companies that do not need to raise are choosing not to."
According to a report released in late April by PitchBook, the National Venture Capital Association, Silicon Valley Bank and Carta, the number of angel and seed deals in Q1 2020 is on par with those in Q1 2019, with 2020 clocking in at nearly 1,000 deals. Early-stage investment in Q1 2020 was just as strong, with over 600 deals, and late-stage deals also carried on 2019's record-breaking momentum.
During the financial crisis, angel and seed deals ticked upward approximately 34% in both count and value, according to PitchBook. Analysts at PitchBook expect this stage of dealmaking to be resilient through 2020, although not quite as strong as in 2008 and 2009. As the trajectories of WhatsApp, Slack, Pinterest, Stripe and Uber suggest, VCs who make angel and seed deals during a recession may find a profitable exit in a few years.
"It's become a common belief that companies formed during a recession end up being some of the most successful," PitchBook analysts wrote in their April report.
Leading Edge Capital's Green, an early Uber investor, told CNBC, "Some of the most innovative and lasting companies have been founded during a recession, so we would expect to continue to see entrepreneurs pursuing new ideas." Green anticipates needs and behaviors to change in the wake of the pandemic, and he says there are talented entrepreneurs ready to take advantage.
However, PitchBook does expect VC transactions to slow over the next few quarters. Many of the transactions announced in 2020 so far are the culmination of efforts begun before the Covid-19 pandemic forced pitch meetings out of the office and into virtual conferences. Maverick's Bhattacharyya says, "deal velocity is a bit slower, but the market is certainly not frozen."There is still $120 billion in "dry powder" available to VCs, according to the PitchBook-NVCA report, but the capital won't be accessible to all start-ups equally. PitchBook expects the absence of face-to-face meetings and new investor conservatism to result in fewer transactions, higher-quality deals and more grounded valuations.
Historical data from the NVCA shows that VCs began 2004 with $73 billion in dry powder. Of that, they invested $22 billion. In 2009, VC fundraising fell by nearly 60% from the year before, and both years experienced dips in VC-backed exits.
Fewer exits mean more strain on the entire ecosystem. Drawing on the financial crisis history, the NVCA predicts that VC funds may take a hit in the quarters to come, and while 2020′s $120 billion in dry powder may help the industry, "it simply will not be nearly enough to meet demand to finance the current operations of start-ups."
Greycroft has approved several new investments during the pandemic, including early rounds in dining and takeout start-up AllSet and machine learning company Frame.ai, but Patricof suggests caution when surveying investments in anything related to advertising, as well as retail and travel.
In late April, fintech start-up Stash announced a $112 million Series F raise, and earlier that month, data-storage company VAST Data became a unicorn with a $100 million Series C round, raising its value to $1.2 billion.
VAST Data CEO Renen Hallak told CNBC that of eight investors participating in the new round, three were new to the company, including lead investor Next47. Two of the new investors, Mellanox Capital and Commonfund Capital, were introduced to the company and decided to invest after the pandemic and subsequent market volatility.
"Biotech is a good place to be," says Greycroft's Patricof.
Ali Behbahani, general Partner of VC firm New Enterprise Associates' health-care team, who has exited health and biotech companies including CRISPR and Acadia Pharmaceuticals, said while everyone in the industry is mindful of the situation, "it's not like everyone's stopped investing in the space. To me the innovation part of it hasn't changed. ... You've seen a lot of companies repositioning to combat Covid-19."
After the SARS outbreak in 2003 and the MERS outbreak nearly a decade later, some of the health sciences companies that repositioned to develop related treatments ran out of funding when those epidemics subsided. However, PitchBook expects continued investor interest in health and biotech over the next few quarters.
Four biotech companies have successfully exited during the pandemic: Imara, Keros Therapeutics, Zentalis Pharmaceuticals and ORIC Pharmaceuticals each listed on the Nasdaq, with the majority pricing at the higher end of their respective ranges and trading well after listing. Keros and Zentalis held virtual roadshows and virtual IPOs in light of coronavirus concerns.
"That indicates demand," Behbahani said. "I would have thought investments would have come to a halt both on the venture and the public side. It's interesting to me that that hasn't happened."
Rahul Chaudhary, head of equity capital markets at SVB Leerink and lead underwriter for the Imara, Zentalis, and Keros IPOs, points to these companies as the trial balloons for other companies seeking exits. "Now that you see a handful of companies that have tested the waters and successfully gone public, you'll see more companies follow suit and access the public markets," he said, as long as the stocks perform in the near-term periods after trading debuts.
Biotechs still waiting to debut include Lyra Therapeutics, which set terms for its IPO last week, and Ayala Pharmaceuticals, which filed for a Nasdaq IPO in early March. According to PitchBook's Q2 2020 report, investors should watch these and other growing biotechs closely for another reason. "Given many companies in this space are still pre-revenue, suspending an IPO puts them in a tight spot when it comes to cash flow."
"Biotech is one of the few sectors that relies almost exclusively on equity financing to operate. ... As a result of that, the biotech sector tends to need the equity capital markets more than any other sector, at least in terms of volume of deals," SVB Leerink's Chaudhary said.
NEA is still open to health-sector deals, Behbahani said, although the stage of a biotech company could make all the difference to a potential investor. "It would be really hard to invest in a commercial-stage company right now until you know [how long this will last]," Behbahani said. The VC investor is eyeing companies' cash runways. Investors must have confidence in a company's cushion to withstand a prolonged downturn,and, for biotech start-ups, delayed clinical trials.
Biotech diagnostic companies that rely on clinical trials may have trouble for another reason, says SVBL's Chaudhary: "Even after the pandemic, the desire to go in [to a hospital] and participate in trials might be low."