By Louis Lehot, a business law partner at Foley & Lardner LLP in Silicon Valley
When the pandemic first hit the U.S. economy, many experts anticipated a decided pullback from comparatively risky investments like startups. Crunchbase reported in March of 2020 that “If past cycles are any guide, we can expect a sharp startup funding slowdown in coming months.†The Harvard Law School Forum on Corporate Governance concluded that “Investors and companies must be prepared to address and negotiate new or reemerging terms as investors seek to de-risk their investments and companies seek financing alternatives in response to rapidly changing market conditions.†Counterintuitively, outside of the travel and hospitality sectors, 2020 failed to usher in the “black swan†moment that had been proclaimed. As we move into spring in 2021, it feels decidedly 1999ish in technology, digital health and life science startups and investing.
Today, as businesses and schools begin preparing for a full scale reopening, we are entering the post-COVID era, but the startup landscape is not the same as it was in 2019 or 2020. Entrepreneurs and investors should take note: the rules of the game have changed, and are unlikely going back to the way they were.
Radical changes can create radically new opportunities, and new opportunities are a gold mine for investors. Despite the Q1 and Q2 pullbacks in the number of deals, 2020 still saw a record amount of VC funding. According to MoneyTree, VC investments reached $130 billion in 2020—a new record—with over 6000 deals. Internet startups were by far the largest vertical for funding last year. Healthcare was a distant second, followed by mobile and telecommunications and then other software.
With the rollout of coronavirus vaccines hitting full steam in the United States, the new $1.9 trillion 2021 federal stimulus program (on top of the $2.5T+ in 2020 federal stimulus programs) and “easy money†policies prevailing at the Federal Reserve (with the Fed’s balance sheet expanding by $8T+), things have gotten decidedly frothy in 2021. Crunchbase reported that January 2021 venture capital funding reached an all-time monthly high, with $39.9 billion in new funding, and then stayed steady at $35B in February. Sectors attracting the most attention were delivery, robotics, logistics, automotive, fintech, and cloud computing.
Pre-seed and seed deals have hit record levels, redefining the categories. While “early stage†in tech once meant being the first money into a company, it now refers to investing after a product has been developed, tested, entered commercial shipment, and demonstrated sufficient product-market fit to merit scaling capital, with some minimum amount of monthly recurring revenues. Seed capital, once the province of “Series A†investors, now refers to a new category of business angels and entrepreneur-funded “scout†funds that looks for companies with revenue. For entrepreneurs who have never raised capital before and have not yet developed a minimum viable product, the universe of “pre-seed†funding is probably with friends and family, and for the lucky ones, a university laboratory, an accelerator, incubator or government grants.
Once upon a time, pre-seed and seed deals were funded with heavily negotiated convertible note rounds and series seed preferred stock. Today, they are largely documented by one of four “simple agreement for future equity†templates posted on the Y Combinator website. The process has been “democratized†and decentralized, and while the bulk of venture capital continues to go into Silicon Valley based companies, the pandemic has totally distributed the workforce to the four corners of the world.
To some extent, the outsized funding of Internet startups and then healthcare simply parallels public sentiment during the pandemic, waves of shutdowns and resurging recovery. Everyone has been coping with how to handle work, school, and life from home, and healthcare provided a consistent backdrop. The real question today is whether those trends will continue into the next few years.
To answer this question, consider the trajectories of the Internet and healthcare. FlexJobs, a service that aggregates postings of remote jobs, lists several major and emerging companies that are either switching to a remote-first workforce or allowing employees to work remotely even after pandemic restrictions are lifted. Amazon, Microsoft, Facebook, and Twitter are on the list, as are Coinbase, Square, and Slack. This trend dovetails nicely with the longstanding trend of digital transformation. Other consequences aside, the pandemic seems to have accelerated the digital transformations of many companies, and that acceleration includes healthcare as well.
Could investors tire of Internet and healthcare startups? Maybe. The massive interest driven by the pandemic could have created a bubble, but again, the spike in VC investments in these fields was not driven solely by the pandemic. If your startup falls within one of these hot fields, you may still be well positioned to attract investors in the next few years.
Investors will want to see that your company can compete effectively with social distancing and pandemic-related changes to spending habits, and virtual meetings are commonplace. Make sure that your business model and your pitch work effectively within the new normal.
Despite all the changes in the last year, the basics of making a deal are essentially the same. Starting a new company is difficult in any setting, and today is no different. But with the right ideas, the right plan, and a bit of tenacity, you can build opportunities from even these unprecedented and challenging circumstances.
Louis Lehot is an emerging growth company, venture capital and M&A lawyer at Foley & Lardner in Silicon Valley. Louis Lehot spends his time providing entrepreneurs, innovative companies, and investors with practical and commercial legal strategies and solutions at all stages of growth, from garage to global. He focuses his efforts on technology, digital health, life science and clean energy innovation. Louis’s clients are public and private companies, financial sponsors, venture capitalists, investors and investment banks, and he has helped hundreds of companies at formation, obtaining financing, solving governing challenges, going public and buying and selling. Louis Lehot is praised by clients, colleagues and industry guides for his business acumen, legal expertise and leadership in Silicon Valley.
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