Venture Capital and Growth Equity During a Market Downturn

The world has been disrupted by the spread of COVID-19 and the pandemic is resulting in an immediate impact on the global economy, all businesses, big and small, and the livelihoods of so many. It is a known saying that many venture capitalists can “see around corners.” However, few could have ever predicted the situation we face today and the devastating implications to the health, well-being and financial stability of so many. 

In an effort to support venture capital and growth equity investors, Greenspring Associates seeks to provide transparency around how the firm is managing and monitoring the COVID-19 crisis across its fund manager and company investments to ensure continuity and support through this unprecedented investment environment. Greenspring’s mission is to deliver outsized venture outcomes by creating and adding value to Limited Partners, General Partners and Entrepreneurs, while making the world a better place through the financing of innovation, which gives rise to economic growth and the improvement of the human condition. “It is times like these that put our mission to the test as Greenspring proves to our employees, our companies, our General Partners and our investors the type of partner we are and the type of partner we aspire to be. We truly believe that reputations can be built and even made stronger in difficult times,” said Greenspring Founder and Managing General Partner Ashton Newhall. 

The firm is dedicating meaningful time to ensuring core investment and business principles are consistent and flow through decision-making processes in times of crisis, leveraging learnings and knowledge of patterns witnessed through multiple economic cycles across the firm’s twenty-year history.

The Current Environment

As of March 31, 2020, global COVID-19 cases were escalating by the day at an increasing rate.  There were ~800,000 to 850,000 known cases worldwide, and the U.S. alone represented ~175,000 cases, over 20% of total global cases. By the time you are reading this, the numbers will have exceeded one million globally. Most Americans have been ordered to stay at home, putting our economy at a standstill. In fact, there are more people ordered to stay at home today than were alive in 1940 (2.6 billion).

There have been substantial and unprecedented government and central bank stimulus packages launched all over the world to mitigate the economic fallout from the virus. The 11-year bull market has abruptly ended, and the February highs for the S&P and Nasdaq are a distant memory. Going forward, private markets will have to deal with a much tighter follow-on financing environment and limited liquidity options for the next few quarters. GDP projections vary, and while the consensus is that the first quarter of 2020 will not be the worst of it due to strong January and February growth, second quarter 2020 GDP will reflect severe declines from job losses, productivity loss and production losses. A strong recovery of GDP growth is currently anticipated in the third quarter, with continued but moderate gains in the fourth quarter.  However, this is subject to the duration of the pandemic, and the ability of the U.S., as well as developed economies globally, to contain the virus and establish solutions for managing future COVID-19 outbreaks.

For context, the U.S. government COVID-19 stimulus package of $2 trillion represents close to 10% of the country’s GDP, nearly double the proportion of the stimulus packages of the Great Depression and the Global Financial Crisis. From a public market perspective, investors are asking themselves if we have reached the bottom, or if there are further declines in value to come. In Greenspring’s view, the worst-case scenario would be if public market lows are reached in a few months, which would extend the market recovery time significantly and exacerbate volatility and general uncertainty throughout the economy.

If the peak-to-trough time period extends out to 15 to 30 months, as was the case in the credit crisis and dot-com corrections, Greenspring estimates a full market recovery could take up to four to five years.

COVID-19 Impact on Venture Capital and Growth Equity

With respect to the venture capital and growth equity asset class, Greenspring believes that global information technology spend will decline in a manner similar to the patterns witnessed in the last two recessionary periods. Information technology purchase decisions will experience delays or cancellations, apart from mission-critical hardware and software purchases. Since information technology sector investments represent approximately 35% of venture capital and growth equity investments, the asset class will be impacted by COVID-19-related declines in both market valuations and the universe of investible companies.

Global Information Technology Spend Decreased in the Last Two Recessions

Source: Gartner Market Databook, March 11 Update.

According to Greenspring General Partner Hunter Somerville, “Small venture or niche growth equity funds experiencing outsized near-term impact from the crisis are of greatest concern. If these funds didn’t allocate enough in reserves, assuming valuations would continue to trend up and to the right, they might face serious dilution or pay to play repercussions should punitive down rounds ensue. Larger funds, or those that have conservatively reserved capital, will be much better positioned in this type of environment.” Given the declines in pre-money A, B and C investment rounds observed pre- and post-9/11 and the dot-com bubble bursting, and pre- and post-Global Financial Crisis, Greenspring anticipates similar patterns to emerge in the weeks and months ahead.

Pre- and Post-Economic Crisis Venture Financing Round Pre-Money Valuations

Source: Greenspring Associates venture investment database.

Such patterns create investment opportunities at potentially more attractive valuations for venture capital and early growth investors that are in a position to commit to new investment opportunities or increase positions in high-potential portfolio companies.

Diversification in Private Equity Investing 

Private equity investing has unquestionably seen tremendous growth since the Global Financial Crisis. Between 2009 and 2019, 832 U.S. buyout funds and 592 U.S. venture capital and growth equity funds were launched (not including micro/seed stage funds)[1]. The rise of private market funds presents a substantial opportunity set for institutional investors to diversify within private equity—across stage, sector, geography and vintage year to minimize the risk of large losses.

Economic downturns and market dislocations create structural opportunities in venture capital and growth equity. While buyout may be subject to reduced access to debt financing, fewer liquidity events and elongated liquidity timelines, venture investments, particularly in early-stage opportunities, are frequently characterized by minimal or no debt in their capital structure and less dependency on near-term liquidity events. 

Venture and Private Equity Median and Upper Quartile TVPI 2000 to 2017 Vintages

Source: Cambridge US Direct Venture Capital and Private Equity Median and Upper Quartile Pooled Funds Benchmarks.

Depending upon the institutional investor type and the goals and objectives of the portfolio, investors may rethink private equity allocation diversification in a recessionary environment. Historic private equity and venture median and upper quartile benchmarks suggest the potential for meaningful venture capital outperformance in vintage years following a recession, as seen in 2010 and 2011.

Compared to private equity buyout strategies, differences could be attributed to the lower entry point valuations of venture and early growth equity following an economic crisis, the lack of leverage on the balance sheets of venture-backed companies and the longer expected investment time horizons. Furthermore, in an environment where fewer venture and growth equity funds are being raised following a downturn, well-capitalized fund managers are uniquely positioned to secure investments in attractive company investment opportunities at modest valuations, with the opportunity to realize significant value at a later stage.

Emerging Patterns

Greenspring’s platform invests in venture-backed companies and venture capital funds, both on a primary and secondary basis. Through the firm’s relationships, proprietary research and data tracked on 8,000+ venture-backed companies, patterns are emerging at the fund manager and company investment level.

According to Somerville, “In direct company investments, we are now seeing more insider rounds via convertible notes, round extensions and some slight down rounds. VCs want to get more of the existing companies they like. Everyone is trying to give companies runway through at least mid-2021. It’s hardest now for the startup companies that have a high burn rate plus a business that’s been severely affected by the lockdowns.”

When compared to the firm's investments in 2001 and 2008, Greenspring’s direct company portfolio as of the COVID-19 crisis illuminates evidence of better-capitalized companies positioned to more effectively support ongoing operations and investments for growth objectives post-crisis. According to Greenspring General Partner John Avirett, “Venture-backed companies are better capitalized than they were before the Global Financial Crisis, enhancing their ability to survive a market downturn.”

This trend toward maintaining stronger balance sheets can be attributed to at least two market factors. First, the rise of the “private public markets.” With companies staying private longer and the rise of a robust venture and growth equity secondary investment market, venture-backed company management teams are projecting longer runways to exit via acquisition or public offering. Second, with recent notable faltering among large, venture-backed companies in the public markets that adopted a “growth at all cost” mentality, company boards are spending more mindshare on unit economics and identifying a path to profitability independent of public market outcomes. “The shift in operational behavior last year helped venture-backed companies move even faster to take action in response to COVID-19, helping to improve economic health and preserve cash runway,” said Avirett.

U.S. Venture Capital Investment Deal Value Prior to Market Downturns

PitchBook Q4 2019 Venture Monitor Report.

Where We Go from Here

Undoubtedly, the COVID-19 crisis will negatively impact financially weaker private market companies across venture, growth and buyout. Financially strong companies operating in large and growing markets will be better positioned for growth. Venture-backed companies will require private financing to support growth for years to come, and Greenspring anticipates more attractive venture-backed company valuations as the pool of investible institutional capital available to the asset class declines. As a result, institutional investors whose objectives are aligned with the asset class will be positioned to benefit from the structural market opportunity created by a disruptive economic downturn.

For additional Greenspring Associates Insights, please visit our blog or contact us at: InstitutionalInquiries@gpsring.com

[1] S&P Capital IQ, April 2020.

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for any investment decision in any private investment fund or other vehicle managed or sponsored by Greenspring Associates, LLC or its affiliates, or for any other investment decision.  Recipients are recommended to seek independent legal, financial and tax advice before making any investment decision. The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction. Information and opinions presented have been obtained or derived from sources generally believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. Any forward-looking statements, predictions or projections are subject to known and unknown risks, uncertainties and other factors which may cause actual results or occurrences to be materially different from those contemplated in such statements. The views contained herein are as of the date written and are subject to change without notice. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from Greenspring Associates, LLC.  The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.