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An economic downturn will mean less funding opportunities for startups — but there's still hope, these researchers found

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  • The coronavirus pandemic has ushered in an economic slowdown, and like any financial hardship, it will impact the ability of startups to fundraise.
  • Through an analysis of the 2008 recession, these Kauffman fellows determined that not only were startups raising less capital, but they were also selling a higher percentage of their company for that capital than before the 2008 crash.
  • But even if some startups struggle during the crisis, some successful ones were born out of the Great Recession, and some industries might actually be deemed more essential after the outbreak is tamed.
  • Click here for more BI Prime stories.

The recent coronavirus outbreak has shocked markets around the world — and US equities, in particular, have dragged into bearish territory faster than any other tumble. But as an institution focused on venture capital and startups, we asked the question: How will current economic conditions impact fundraising at the startup level?

If history can teach us anything about the trials and tribulations startups have to go through during a downturn, we decided to look at the most recent market crash in September 2008 and looked at how VC-led rounds were impacted during the first full year after the crash.

We found that across all rounds types (Seed to Series D) that the median round size went down. Founders across the board were raising lower amounts of capital, and in some cases, over 30% less. It's unlikely that startups decided to become more capital efficient overnight — we think the market forced it.

Kauffman fellows Figure 1: Median early-stage dollars raised between the years 2007 and 2012

Note: Median round sizes are typically lower than the mean because round sizes tend to follow a power-law like most things in startups. But medians represent trends more clearly because outliers do not throw off the data. This is why we present medians.

Compounding this, in 2009, we also saw a dramatic increase in the median percent equity sold per round.

Kauffman fellows median percent equity sold per round.

This means that not only were startups raising less capital, but they were also selling a higher percent of their company for that capital than before the 2008 crash.

And fewer rounds were happening in 2009 (with the notable exception of seed):

Kauffman fellows number of rounds per year

Overall, if we can learn from history, there is a decent chance startups are in for a rough time ahead. It is a reasonable assumption that capital will be harder to raise, and many startups will raise at a lower valuation than before this crisis. We are advising startups that have not hit profitability to curb spending, focus on revenue-generating products, and think very carefully about new hires.

To put this into perspective, in 2008, a Series A company raised a median of $4 million for 14% of the company. This leaves an effective valuation of a $28.5 million post.

In 2009, however, 30% fewer companies raised a Series A. And the companies that did successfully raise raised 12.5% fewer dollars (a median of $3.5 million) and had to sell 25% of their company (78% more). This leaves an effective post-money of $14 million post, basically half the valuation of the year before. 

The silver lining

There are a handful of factors that suggest that the current tumble is different than any prior downturn. Pandemic infused uncertainty, consumer demand and perception shifts, low-interest rates, increased globalization of systems, etc., will all play a role in determining how and when a recovery will happen.

But we have to continue to believe in better days ahead. After all, we know that the last recession (2008 to 2009) saw the birth of some of the most iconic companies in the past decade. Uber, Airbnb, Slack, Pinterest, WhatsApp, and Square are just a handful of the companies forged within the parameters of a downturn.

In our conversations with a number of investors and thought leaders in the space, we also believe that a handful of existing and new categories will advance through 2020 and beyond.

For example, the healthcare and life science sector may experience a more favorable regulatory environment moving past the coronavirus age. Companies within the future of work thesis may move beyond early adoption into mass-market categories, like education and healthcare. As investors in Zoom, we've seen the extraordinary rise and adoption of remote work and believe that video communications will continue to enhance human connectivity post-pandemic.

What about telemedicine? Will current stay-at-home policies change consumer perception towards digital health in the long run? At the same time, what will startups like Carbon Health, Remedy, and Plushcare do to continue to make the teledoctor experience more human?

While we don't know how this downturn will play out, we do believe in one thing: Some of the most iconic companies of the next decade will undoubtedly be launched in this pressure cooker of change, and that this is a unique and pressing opportunity for founders alongside equally intrepid investors to partner in building the economy of the future. As famed UCLA basketball coach John Wooden said, "Stay the course, when thwarted try again, harder, smarter, persevere relentlessly."

We are certainly staying the course. 

Methodology

All the data used in the development of all charts and insight was obtained from Crunchbase private-market data.

  • Venture rounds between January 1, 2007, to December 31, 2012, were included in the graphs above. 
  • Early series rounds marked seed, Series A, Series B, Series C, and Series D were included in the analysis.
  • For a given round, round percent was calculated by dividing raised by round's post-valuation. Please note that the post valuations for a round isn't as populated as the dollar raised.

Disclaimer from the data provider: "Crunchbase's dataset is constantly expanding, but there are gaps. A company may not have all the founders and chiefs listed on its Crunchbase profile or have the complete details regarding the executive's education listed in detail."

Collin West's passion for supporting entrepreneurs is his 'true north' for his work at Kauffman Fellows, a two-year mastery level program in venture capital with over 500 alumni in 40 countries. As cofounding partner of Kauffman Fellows Fund, Collin works with the next generation of founders by first building an authentic relationship, then by providing capital and resources. Collin also leads their data-driven investment team. Previously, Collin was on the founding fund team at Correlation Ventures and was an IT strategy consultant with Accenture.

Nihar Neelakanti is an investor at Kauffman Fellows Fund, produces "The Arena Podcast," and writes the Journal Newsletter by Kauffman Fellows. The firm's investments include Zoom, Carta, Tally, Groww, One Concern, and Catalog DNA. Previously, he was an analyst at Correlation Ventures, a venture firm out of San Francisco that has invested in notable consumer companies such as Casper, Cotopaxi, and Imperfect Produce. He also cofounded Vendima Bags, a direct-to-consumer luxury bag startup. 

Prior to the Kauffman Fellows, Gopinath Sundaramurthy worked with IBM Watson Health as an advisory data scientist, where he led multiple analytical and research studies for large pharmaceutical clients. Gopi holds a masters and PhD in systems biology from the University of Cincinnati College of Medicine. His thesis was based on studying the mechanism of complex disorders using mathematical and network models. He completed his bachelors in engineering from R.V.C.E, India.

NOW READ: Now's the time to invest in biotech, according to VCs who've analyzed 1,227 early-stage biotech startups. Here's why they're so sure.

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