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E-MailWill Gornall is Assistant Professor of Finance at the Sauder School of Business at the University of British Columbia. This post is based on a recent paper by Professor Gornall; Paul A. Gompers, Eugene Holman Professor of Business Administration at Harvard Business School; Steven N. Kaplan, Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business; and Ilya A. Strebulaev, the David S. Lobel Professor of Private Equity at the Stanford Graduate School of Business.
Related research from the Program on Corporate Governance includes Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups, by Jesse Fried and Brian Broughman (discussed on the Forum here); Do Founders Control Start-Up Firms that Go Public? by (discussed on the Forum here); and Do VCs Use Inside Rounds to Dilute Founders? Some Evidence from Silicon Valley by Jesse Fried and Brian Broughman (discussed on the Forum here).
In this paper, we survey over 1,000 institutional and corporate venture capitalists (VCs) at over 900 VC firms to learn how their decisions and investments have been affected by the COVID-19 pandemic. Understanding how COVID-19 impacted venture capital is important because many of the most innovative young companies depend on a steady inflow of VC money. The sudden arrival of the COVID-19 pandemic has dramatically affected many facets of the global economy, and many commentators worry this shock will choke off venture capital flow. VCs have variously described COVID-19 as the “Black Swan of 2020” and claimed the “global VC market has completely locked up.” If such dire predictions are true, that would have important consequences for the innovation ecosystem.
We measure the impact of COVID-19 using a survey of venture capitalists. Our results are based off answers by VCs who make up a significant fraction of the industry, including over 900 institutional VCs at over 800 VC firms and over 100 corporate VCs representing over 100 corporations. We compare their survey answers to those provided by a large sample of VCs in early 2016 and analyzed in Gompers, Gornall, Kaplan, and Strebulaev (2020), which allows us to see how COVID-19 has changed VC attitudes.
First, we consider how the pandemic is affecting new investments. VCs report that during the first half of 2020, their investment pace is 71% of their normal, expected activity. They expect that their investment pace will be 81% of their normal pace for the rest of the year. Roughly one-quarter report that they have struggled to evaluate new deals. This is consistent with the behavior of VC investment in past recessions, as shown by Howell et al. (2020). The extent of the decline, however, is expected to be more modest than in the dotcom bust of 2001 and 2002, when investment declined by more than 50% and the financial crisis, when investment declined by 30% in 2009.
Next, we asked the VCs about their investment terms during the COVID-19 pandemic. Although the VCs expect investment terms to become more investor friendly, the terms they reported using were actually more founder friendly than the terms reported by GGKS (2020).
We also asked VCs about the status of their existing companies. They report that 52% of their portfolio companies are positively affected or unaffected by the pandemic; 38% are negatively affected, but not in critical condition; and 10% are severely negatively affected or in intensive care. Consistent with this, the VCs expect the pandemic to have only a small negative effect on their fund internal rates of return (IRRs), down 1.6%, and cash-on-cash returns (MOICs), down by 0.07. The VCs also remain optimistic about their own performance, with 91% believing they will outperform public markets, and overall VC performance, with 75% believing the VC industry as a whole will outperform.
Finally, despite nearly half of the VCs’ portfolio companies being affected in some way by the COVID-19 pandemic, we find surprisingly little change in the allocation of their time to helping portfolio companies relative to looking for new investments. GGKS (2020) found that VCs tended to be active in their portfolio companies and the VCs in our current survey remain active in their companies, albeit not substantially more so. Throughout, we find modest differences between institutional and corporate VCs. This suggests the corporate VCs have incorporated many of the practices of institutional VC firms.
Overall, we conclude that the most dire predictions of the impact of COVID-19 on venture capital have not materialized. Although the pandemic has not yet run its course and a lot of uncertainty remains, our evidence suggests that the VC industry and its portfolio companies have reduced their activity less than in previous recessions and have been more resilient than many other sectors of the global economy.
This is consistent with two possible stories. First, VC-backed companies may have been spared from the worst of COVID-19 due to the nature of their businesses. These companies may be immunized to the negative impact of lockdowns by being more able to pivot to remote work (Ding, Levine, Lin, and Xie, 2020) and by having large cash reserves and little debt (Papanikolaou and Schmidt, 2020). Second, VCs’ portfolios may gain in value in disruptive and volatile environments. If portfolio companies are real options on innovative technologies and business models, an increase in volatility may increase the value of those options and thus the value of a VC’s portfolio (Fluck, Garrison, and Myers, 2006; Peters, 2018). Regardless of the channel, VCs’ relatively strong performance during the pandemic is consistent with much lower systematic risk than the VC industry exhibited in the dotcom crash and the global financial crisis earlier this century.
The complete paper is available for download here.
