In early March, Sequoia Capital released a memo with tips for founders to deal with the pending crisis. The advice has been echoed by a number of different VCs, which basically consists of: • Slow unnecessary spending/increase runway; • Drawdown lines of credit/reduce counter-party credit exposures; • Close financings immediately (don’t be greedy); and • Be vigilant for “acquihires” or acquisitions.

Recently, a quote from the US VC community got some play on Twitter, “We are cutting all valuations by 50% and a flat round is the new 3x up.” This makes sense if the market was already frothy, which is what you would expect in a market where there is little to differentiate investors on other than price (i.e. there is limited value-add for most VCs so they just offer higher valuations to win deals). This is less likely to be the case in SEA, where valuations don’t feel like they’re significantly out of touch with fundamentals – Yes, fundamentals can apply to early-stage companies. However, we do believe that there will be a reduction of enthusiasm in the risk environment, it’s only natural. The LPs that invest in VC funds will be less likely to invest in follow-on funds as they nurse wounds from equity market drawdowns and raise liquidity for other parts of their portfolios. This in-turn will cause GPs to re-evaluate their propositions and their infrastructure commitments.

The Beauty Pageant

Those investors that were making bets in the hopes that there would be a greater fool (i.e. investing with Keynes’ beauty pageant in mind) are probably going to be caught playing Russian roulette with a glory-hole guillotine. As a whole, this will force investors to focus on career risk and limit their subsequent portfolio exposures. They can blame any mishaps in the current portfolio on the Black Swan nature of the current event but it will be more difficult to do so for subsequent allocation decisions. It could take a while to happen but we’re confident that there will be a reduction in risk-seeking capital available to entrepreneurs that are building world-class businesses.

Incubators and accelerators that were basing their valuations off UK or US levels will likely find it more difficult to find funding for their portfolio companies. It was already getting more difficult prior to this macro shock so this will only exacerbate the current situation.

We believe that we haven’t seen the worst of it yet – both from an economic and a financial markets perspective - it’s important to distinguish between the two. Firstly, addressing the financial markets, the S&P500 fell 33% from its record high in February over a couple of days, the fastest drop ever recorded. This doesn’t necessarily mean that the market is now fairly valued or all of the bad news has been baked in. Financial markets generally go from panic to euphoria – they rarely rest at what could be considered “fair value.” They might be hovering at a point that’s closer to fair value now but that is without considering the economic impacts from the global shutdown. Public markets are typically priced on their Price/Earnings multiple, it goes to reason that if the denominator falls off a cliff, the multiple will sky rocket unless price is adjusted to reflect the new reality.

Over the last fortnight, markets have been adjusting to the monetary stimulus that governments are proposing. They have gone from pricing in “This is the worst thing ever” to “Don’t worry, the Government will backstop the markets again.” This isn’t productive in the long-term and creates significant moral hazard, rewarding those that take excessive risks at the expense of the prudent operator. As a result, we’ve seen a bounce in equity markets.

We’d argue that companies have been so busy adjusting to a new remote/WFH world that they haven’t had to assess the damage to their business. There will also be a number of technology companies that believe they are immune to economic fluctuations. Software contracts have been treated as “first-lien debt,” meaning that people are going to pay their software contracts regardless of the macro environment. However, as the linked article suggests, this fails to take into consideration second order effects – businesses can’t pay a contract if they are no longer a going concern. As the second order impacts are reflected in company guidance, we’re likely to see a more significant adjustment in public markets. This will take some time to be reflected in private markets because of the nature of the feedback cycles – it’s easier to say you have reduced volatility in your portfolio when you’re only marking-to-market each quarter vs daily. We’re now talking about the broader economic impacts, which are difficult to quantify because there aren’t many good analogues. Anecdotally, from a markets perspective, this could be similar to ’87, where liquidators were still working through situations in ’92.

We’re not going to speculate on how long the shutdowns will last or where unemployment will get to in the US. The only economic analogue that I’ve seen is from the Arkansas Gazette in 1918, where the Spanish flu caused department store revenues to drop 50% and other merchants noted a 40-70% drop in businesses. It looks like a reasonable bet that there will be long lasting economic implications as a result of the global shutdown. It’s difficult to make the argument that we will see a “V-shaped” recovery considering the anecdotal evidence, suggesting that numerous businesses are going to be shuttered so even if things go back to normal, there won’t be SMEs that will stand at the ready to hire a capable and willing workforce.

The Acid Test

This is an excellent opportunity for those businesses that can prudently navigate the landscape, stay lean, and stay operational. Coming out the other side, there will be far less competition and partners will be hungry for opportunities to expand their business. Potential customers will be falling over themselves to work with you if you have a value-add. If you’re running a digital-first business, even more so.