Silicon Valley Venture Capitalist Confidence Index™
(Bloomberg ticker symbol: SVVCCI)
First Quarter – 2020
(Release date: May 7,2020)
Mark V. Cannice, Ph.D.1
University of San Francisco School of Management
The Silicon Valley Venture Capitalist Confidence IndexTM (Bloomberg ticker symbol: SVVCCI) is based on a recurring quarterly survey (since Q1 2004) of Silicon Valley/San Francisco Bay Area venture capitalists. The Index measures and reports the opinions of professional venture capitalists on their estimations of the high-growth venture entrepreneurial environment in the San Francisco Bay Area over the next 6 – 18 months.2 The Silicon Valley Venture Capitalist Confidence IndexTM for the first quarter of 2020, based on a March 2020 survey of 26 San Francisco Bay Area venture capitalists, registered 2.33 on a 5-point scale (with 5 indicating high confidence and 1 indicating low confidence). This quarter’s Index measurement plummeted from the previous quarter’s Index reading of 3.6 and is the lowest reading of VC confidence in the over 16-year history of this on- going quarterly research. Please see Graph 1 for quarterly trend data.
Confidence among Silicon Valley Venture Capitalists in the future high-growth venture entrepreneurial environment in the San Francisco Bay Area plummeted to an all-time low point in the first quarter of 2020. The Q1 2020 reading of 2.33 is far below the previous low point of 2.77 during the depth of the financial crisis in Q4 2008. The first quarter reading is also the steepest quarterly drop in the 16-year history of the Index (1.27 point decrease from Q4 2019 reading – a 35% drop). Of course, the tragedy of the health pandemic and the accompanying economic shutdown and general uncertainty drove this sharp decline in sentiment. Still, the high growth venture industry, while subject to health and economic challenges like other industries, has its own dynamics and its own longer-term outlook that makes the insights and expectations of venture investors uniquely valuable in assessing the long-term outlook for innovation and growth in the U.S. and world economy in this extraordinary time. In the following, I provide many of the comments of the participating venture capitalist respondents that validate their confidence rating along with my analysis. Additionally, all of the Index respondents’ names and firms are listed in Table 1, save those who provided their comments confidentially.
Most of the responding venture capitalists in the March 2020 survey expressed heightened concern over the health crisis and its impact on the venture environment. Paul Tuan of Andra Global expects “carnage in venture due to COVID-19.” John Malloy of BlueRun Ventures offered “Obviously we all need more clarity on the scope & duration of this pandemic. This is a national & global crisis that needs all of us to work together by staying apart. Stay safe.” Shomit Ghose of Onset Ventures provided context, maintaining “We’ve had economic crises before: the Great Depression and the Great Recession of 2008. Importantly those were economic crises with economic causes – over-speculation – so lent themselves to economic cures, costly and painful as they may have been. Speaking from a Silicon Valley startup perspective only, the current economic crisis has a biological cause and will not readily lend itself to an economic cure. Startups should batten down the hatches.” Another venture capitalist respondent who provided commentary in confidence, expects a “general economic slowdown due to COVID-19.”
Uncertainty is the watch word. Bill Reichert of Garage Technology Ventures indicated “Of course, I have very high confidence in the future of the venture entrepreneurial environment! But in the near term, we are all going to have to make our way across a collective Valley of Death. As we saw in the last two crunches, the problem is not a lack of money – there is plenty of venture capital cash available. The problem is a lack of visibility. Except for the fortunate few businesses that are actually thriving because of the crisis, entrepreneurs and investors just can’t see when and where customer demand will return over the next six to 12 months. Funded companies selling to enterprise should be able to survive the crossing, but it’s going to be tough for seed stage startups and early stage companies selling to SMBs and consumers.” Eric Buatois of Benhamou Global Ventures added “Covid is creating a lot of uncertainty. The software B to B business is less impacted than B to C, but there is a lot of uncertainty and how the economy will restart is unclear. We see some good signs since some factories have reopened in China. Some of our portfolio companies especially in ecommerce and communication and collaborations are seeing strong demand.”
The economic collapse has led to a focus on portfolio assessment. Dag Syrrist of Vision Capital expects “All funds will be first/foremost focused on existing portfolio triage, and until/unless the health crises are mitigated, the financial impact can’t be solved. Yes, some pockets of companies and solutions that have an immediate opportunity to help/support the crises, but overall, we’re going into a 6-9 month recession, in addition to a human crisis in lives lost and dislocation, significantly worse than 2008. We’ll do okay on other end, but there is no line of sight to that outcome and there’s no evidence that there will be leadership to provide it.” Jon Soberg of MS&AD Ventures confirmed “With the uncertainty in the markets caused by COVID-19, everyone is looking at existing portfolios first, so it will be a tough environment for startups and for VC fundraising for a while. Once we get through it, I think innovation will be the best investment area in the world, so I am optimistic for a good bounce back once uncertainty clears.”
As the previously welcoming economic environment disappears, firms’ sources of sustainable competitive advantage or lack of them are being revealed. Kurt Keilhacker of Elementum Ventures reminded “Many ventures that were built on a mere business model innovation now find themselves with little to enter a new economic season. True technological innovation will continue to find new and promising markets even in a time of economic uncertainty.”
Capital efficiency will be the priority. For example, Bob Pavey of Morgenthaler Ventures commented that the “current environment will put a lot of pressure on small companies needing cash.” Bob Ackerman of AllegisCyber concurred, saying “The current economic environment puts tremendous pressure on startups to reduce their expenses and capital burn. The high costs of doing business in the Bay Area will exacerbate the pressure on these companies and potentially makes them less attractive to new investors who are focused on capital efficiency as well as business fundamentals.” Dixon Doll of ImpactVC shared “Having experienced several crises like this, (9/11 and 2008-09, when I was the NVCA chair), I believe/predict we will go through 2-3 quarters of an ugly panic period, after which the SF Bay Area will rebound as the vibrant leader of the entrepreneurial ecosystem globally. We have a unique culture and support ecosystem for startups that is at critical mass and unmatched anywhere else in the world. During these volatile times, entrepreneurs (and VCs) must remember that ‘cash is king’.” Another VC respondent noted that the “uncertain length of economic recovery will slow sales cycles for startups.”
Ricky Lu of Cybernaut Zfounder Ventures pointed out “Most obviously, people are not going to work and working from home does not fit for every company. Startups with negative cashflow and low cash reserve will feel the most pain. Secondly, the financial market is experiencing a liquidity crunch at this moment. The equity market plunge will affect the IPO market and startups are likely to postpone their IPO plans. This will affect investor’s IRR and confidence on future investment. I would also expect a significant decrease in new corporate debt issuing in next 6-12 months and that would result in less cash in their bank account. This also means a pause on M&A activities.” To this point, the number of investments in Q1 declined from the previous and year-earlier quarters, although total invested capital remained roughly flat.3
Time to exit will increase and valuations will come down. Howard Lee of Founders Equity Partners explained “The COVID-19 global crisis is unprecedented in scope and magnitude with nearly all sectors impacted. A prolonged downturn that is longer than the Great Recession will lead to compressed valuations and an IPO market that will be closed to nearly all private companies. While some M&A activity may return when the capital markets stabilize, these unfavorable exit trends will force private companies to prioritize balance sheet preservation in anticipation of extended fundraising cycles. At the same time, venture investors will look to focus their attention on their existing portfolio companies and move cautiously, if at all, on new investment opportunities. Viewed through a different lens, opportunities may present themselves in another interesting way – through liquidity needs of existing shareholders. The combination of lengthened times to exits for private companies in a downturn and compressed valuations will create opportunities to purchase shares in strong companies at attractive prices. While we know we are in the depths of this global crisis, where market volatility is high and pricing is challenging, the ability to act on these new opportunities will depend to a large extent on the rate of convergence of the bid-ask spread in this uncertain and unpredictable environment.” In fact, exit activity, critical to the business model of venture firms, declined significantly in Q1 2020, both in terms of total value of exit and the number of exits from the previous and especially the year-earlier quarters.4
Given the magnitude of the shock, the link and impact between global and national response to local business and venture operations is still being determined. Baris Guzel of BMWi Ventures reflected “Many things have been written about the current situation, but so far my favorite term has been the ‘Great Cessation’. Probably for the first time in modern financial history, we are observing a global and synchronized shutdown of economic activities. Recently announced unemployment figures prove that, compared to other historical financial crises, this is much more severe in terms of the speed and magnitude of the downturn. I do believe that the rapid measures undertaken by the Fed and the Congress were positive, yet these will have a limited impact given the historically low interest rates and, most important of all, the unusual nature of the shock – pandemic. I’m convinced that the near-term economic environment is closely tied up to a few factors: 1. how quickly we can flatten the curve; 2. supply of testing, PPEs and critical medical equipment; 3. development of vaccines/ cures. Unless there is clarity about these, it will be hard to estimate what is next.”
The role of government and the private sector in response to the crisis is up for debate. Tim Draper of Draper Associates emphasized “This government overreach is giving us a feel for what a Bernie presidency would have been. The grocery store looked like Soviet Russia today — bread lines, stores closed, empty shelves. We need a quick private sector recovery and people need to go back to work. The government should flatten the curve for two weeks and then back off and let us prosper without their interference. Otherwise, we will have some dark days ahead.”
Other venture capitalist respondents, while cautious, expect a bounce back in the new venture environment…eventually. Steve Harrick of Institutional Venture Partners acknowledged the “huge macro shock prompting recession and multiple compression.” Mr. Harrick continued, saying “capital efficiency will be prioritized over growth,” and he expects “recovery from here.” Jeb Miller of Icon Ventures agreed, noting the “significant shock of the coronavirus pandemic and the impact it will have on the fundraising and exit markets.” Mr. Miller went on to say “I believe the Bay Area will re-emerge as the epicenter of startup activity, but it will take significant time and effort to recover from this tragedy. We will return to capital efficient business models and will likely require a correction in the local cost structure in order to rebuild our momentum.” Mohanjit Jolly of Iron Pillar stated “There are quite a few unknowns at this time, given the pandemic: the duration, long- term intensity, likelihood of multiple waves, timeline for a therapeutic etc. The unprecedented set of events will clearly slow both investment and M&A/exit activity (although there will be plenty of distressed transactions and acquisitions, as collateral damage). But, given the amount of dry powder that investors are sitting on, I do see a wave of increased investment activity in the market in 2021 as the overall situation stabilizes (again, the big assumption in my comment is that there isn’t a recurrence/mutation of the virus and that we start returning to ‘normalcy’ over the next couple of quarters).”
Another VC respondent provided a number of reasons for moderate confidence in the next 12 – 18 months, listing: “Investors, and entrepreneurs alike, have learned from previous shocks to the system. They may be late to react but do come up with innovative strategies to manage their current investments, and also incorporate their learnings when making new investments.” The same respondent continued, asserting “We will see the rise of new business models and companies – ideas that we have not thought about yet. Prices will come down and that will excite those that have been waiting on the sidelines. M&A activity is, surprisingly, not stalling – those deals that are in progress are continuing. The current attitude is – this too shall pass. And finally, investors see this as a ‘couple of quarters’ phenomenon – time will tell if that is indeed the right thinking or not.”
Declining current valuations create the potential of enhanced ROI of new investments. Sandy Miller of Institutional Venture Partners wrote “We have had a total price reset in private financings for high growth tech companies. Last round valuations are not relevant anymore. So, we are back to fundamentals. This is the kind of venture environment where the most robust returns have been in the past. 2020 and 2021 should be stellar vintage years for late stage venture investments.” Alex Fries of Alpana Ventures predicted “Once the Virus is gone, I expect a ‘Unicorn’ kind of comeback. There is plenty of cash sitting around and investors will jump into great deals and quickly.” Another VC stated “I’m quite bullish especially in the sectors that I invest in – social, gaming, wellness, healthcare. Forced behavior change is going to have lasting effects, and create new opportunities in consumer/prosumer space. Also, I expect the recovery to be V-shaped because this is a health problem, not a systematic problem with the financial system as it was for other recessions. Hopefully we can get the virus under control :).”
Providing a highly detailed analysis of the likely impact of the health pandemic and economic shock on venture fund-raising, investment, and valuations, a VC respondent who requested anonymity, contributed the following. “Although this year will likely prove to be an excellent year for investment returns when one looks back seven to ten years from now, three factors will weigh on the venture environment for the next six to 12 months, and then we should expect improvement: (1) valuation expectations – it often takes several months for the valuation expectations of entrepreneurs to adjust to the ‘new reality’ in any downturn. The venture capital firms see more immediate effects from public market downturns (see below), but it takes time for entrepreneurs to adjust their sights downward on valuation. Thus, there is usually a period when venture investments are delayed or significantly diminished in volume simply because the valuation gaps cannot be closed. As funding needs become more desperate for existing companies, they adjust but it often takes months; with respect to early-stage funding that should continue without too much effect on valuations. In fact, the number of new candidates for early stage funding should expand as the opportunities at startups will now be attractive compared to fewer opportunities at other companies; a lot of experienced talent becomes available in downturns. (2) Public market valuation declines usually reduce the amount committed to venture capital funds in the form of commitments – i.e. it is harder to raise a new fund. One reason for this is that the portfolios of large institutions are now overweight alternative investments like venture capital simply because the overall portfolio value has diminished; thus, sector allocation in institutional portfolios tends to dampen investor interest in venture capital funds. Further, public market declines reduce the number of companies going public for several months until markets stabilize and companies adjust to new valuation realities. With IPO liquidity diminished, that competitive avenue for public capital is less of a threat for acquirers so the merger/acquisition valuations tend to follow the public market valuations lower. Until expectations on the part of late-stage boards adjust to the new valuation realities, the late-stage companies tend to ‘hunker down’ with their capital and try to wait out the downturn, reducing financing, IPO, and M&A volume and reducing exit liquidity. There is a reduction of liquidity and transaction volumes for a few to several months after the start of a downturn. (3) Even funds that were ‘raised’ before the market break have what is called ‘committed’ capital – meaning limited partners (a term used to include all passive investors in venture funds because not all funds are structured as partnerships) during the expansion years contractually committed to fund capital calls into the venture funds. However, the reality is that the limited partners communicate with the general partners and signal whether now is a good time to make a capital call or not, and often times capital calls get delayed and some investors may renege on their capital call commitments. Accordingly, the general partners become much more selective in the company selection for investment and push harder on valuations. Overall, there tends to be a reduction in transactions and reduction in valuations in these circumstances. As above, until everyone in the ecosystem adjusts their valuation expectations to the new reality – a process which takes time after the peak – there is diminished transaction volume and diminished funding. Even a promising early-stage startup will face a longer time to funding, and more derisking will be needed to draw in funding. This downturn was caused entirely by an exogenous event – the corona virus. Thus, if that cause can be mitigated, the public markets will respond first, and will take the venture ecosystem with it toward increasing liquidity, higher valuations, and commitments to venture funds. Until that time, we will be in a muddle through venture market with the best deals getting funded and acquired, and others muddling through.”
In sum, the global health crisis has led to a complete disruption of the world economy along with the entrepreneurial environment of Silicon Valley. With the VC Confidence Index at an all-time low in the 16-year history of this ongoing research, it is reasonable to expect that a shakeup of the venture environment is at hand. This shakeup will include challenging realignments of business models and deferments of needed financing that will lead to the demise of some otherwise promising ventures. Valuations of existing ventures and new startups will decline along with their public market analogs and general asset deflation for some time. However, it is often in the midst of abrupt Schumpeterian transitions that new methods of business and even new industries are created, and Silicon Valley has often been the home of such creation. While the wide digitalization of human interaction may lead some to believe that the importance of place has been diminished, beyond place, there lives a culture of entrepreneurial optimism and innovative vision that grows a bit more every day – particularly in the Spring and Summer of California’s Silicon Valley. Onward!
1 Dr. Cannice is Professor of Entrepreneurship & Innovation with the University of San Francisco School of Management. https://www.linkedin.com/in/markcannice/
2Questions about this ongoing research or related topics may be sent to Prof. Cannice at Cannice@usfca.edu or by LinkedIn.
3 PitchBook-NVCA Venture Monitor Report Data Q1 2020
4 PitchBook-NVCA Venture Monitor Report Data Q1 2020
Mark V. Cannice, Ph.D. is Professor of Entrepreneurship and Innovation with the University of San Francisco School of Management. The author wishes to thank the participating venture capitalists who generously provided their expert commentary. Thanks also to Jack Cannice and James Cannice for their copy-edit assistance. When citing the Index, please refer to it as: The Silicon Valley Venture Capitalist Confidence Index™, and include the associated Quarter/Year, as well as the name and title of the author.
The Silicon Valley Venture Capitalist Confidence Index™ is a trademark of Mark V. Cannice. Copyright © 2004 – 2020: Mark V. Cannice, Ph.D. All rights reserved.