While the final human toll of coronavirus is still to be determined, one thing is for certain: COVID-19 is leaving a deep mark on our economy and creating an abundance of fear. The Dow, S&P 500 had the worst March since the Great Depression, as investors are assessing the pandemic’s impact on the slowing American economy. In Asia, the toll had already been heavy, with S&P Global Ratings estimating that the COVID-19 crisis could wipe out $211 billion from economies across the region.
In times of crisis (either real or perceived), investors turn their focus to their core businesses and assets, seeking greater liquidity from non-core investments to weather the situation. The turbulence that creates in global equities and bonds markets is well-documented, but what is less visible is the selloff in the most illiquid of all investment types: VC direct investments and VC fund stakes.
Fire sales of VC fund stakes are most likely to be initiated first by high net worth individuals and some family offices, who seldom have the sophisticated asset allocation models of institutional investors, or the ability/stomach to hold through cycles. But there could come a time when even institutional investors could start exiting stakes causing the discounts to deepen, which was witnessed during the global financial crisis of 2008.
We are now in the early days of what could grow into the biggest public health crisis we will see in our lifetimes. Vaccines for the coronavirus are, according to experts, years away from commercial readiness and Harvard epidemiologist Marc Lipsitch has said that this particular strain could become a pandemic that affects between 40% and 70% of the world’s adult population.
Our understanding of what we are facing is still rudimentary, but as information trickles into the markets over the next six to 12 months, I believe we are going to see an increasing number of owners of VC stakes testing the waters to generate liquidity.
For investors in the secondary market – in other words, the providers of liquidity – the current situation presents and will present a massive opportunity to buy direct stakes in companies and LP stakes. Focusing on opportunities with solid underlying assets that are for the most part not operationally affected by the coronavirus, will be a winning strategy. When liquidity is at a premium, the providers of said liquidity will set the price and can secure good assets at very attractive prices.
And in this new VC paradigm, it’s the businesses that are focused on profit and positive unit economics that are going to attract the lion’s share of funding. We’re already seeing this effect play out in China, where fundraising by startups has plunged almost 40% to $6.8 billion so far this year, from $10.7 billion in the same period in 2019. Additionally, only seven China-based funds have closed so far this year, raising $210 million, compared to the 21 funds that closed in the same period last year, raising $2.4 billion.
In this increasingly sparse funding landscape, many venture-backed companies are going to become less viable, leaving those focused on positive cash flow generation to take most of the funding pie. As the old proverb goes, fortune favors the bold, and this macro shock will surely yield amazing opportunities for those that know how to find value in the VC landscape. Providing liquidity at a time when liquidity is at a premium will be a great seat to sit in as this too shall pass.
This article was also published in Deal Street Asia