#originally posted on Evernote#
7:10 AM PT: Lessons Learned from China
Jenny Lee, Managing Partner, GGV Capital (KF Board of Directors)
Helen Wong, Partner, Qiming Venture Partners (KF Class 8)
How do you feel, especially as the crisis began in China?
- Jenny: it was hard, the first month was all about shutdown and working with the portfolio, but then it calmed down, just for the crisis to pick up in US and Europe. I’ve been through several down cycles, so this is not the only one. And we will come out of it.
- Helen: When the virus first came, we didn’t take it too seriously and things started to get more serious when Wuhan got lock down. But the world was not taking the crisis as serious outside of the US. And now things seems it is the opposite: China is calmer but the other regions are now in crisis management mode
Managing portfolio
- Helen: portfolio was affected in different ways: offline companies were severely affected, whereas online education and entertainment are doing well. The most important thing is to ensure 12 months or even better 18 months cash run. If they are in the middle of a fundraise, don’t try to negotiate the details, if the VCs come with lower valuations, accept it. If you’re into a zero revenue situation, do whatever it takes to survive (e.g. think how can you find
- Jenny: out of 200 portfolio companies, about 100 are in China and the other half is in the US. The first status check is the cash and run rate. We advised companies to take the worst case situation. If they are not generating revenue, what is the gross burn in terms of months (6, 12 and 18 months groups). Once we did it, we had 10% in the 6 month gross burn, 20% in the 12 month gross burn and the rest are in the 18 month gross burn. If they are in the high risk, we need to take more drastic measures. In cash inflow, we look at turn their account receivables into cash, leverage the government subsidies, get grants and loans. In cash outflow, we need to look very carefully if you’re cutting too much to jeopardize R&D and future. All companies are cutting headcount, but we are advising not to be too extreme. Sometimes it is better to cut salaries of founders and replacement of salaries with stock options. For the companies that have more than 12 months run-rate, we advise this is a good time to acquire talent (and also defend against more aggressive large corps).
- Jenny: It is also a good moment to change habits and business models. For example, one education company has 3,000 teachers going online 1:5 (teacher:student). It used to be that the teachers were used to go to the office to hold the lessons, but COVID-19 allowed them to realize that they can cut fixed costs drastically as teachers don’t need to go the their HQ to host the lessons.
- Jenny: we have a drone company that discovered a new use case of their product to deliver goods in Wuhan. We need to balance both the crisis mode to an opportunity mindset, as tough time will go away in the next 6-18 months. If the companies become leaner and survive, they will emerge quite strongly.
- Jenny: we are also doing check-ins bi-weekly with all the entrepreneurs.
Doing deals virtually
- Jenny: we did a US$3M series A all online, just closed it. All partners did all through Zoom, including diligence. We are also trying to close a transaction that we were in the middle of diligence, and now are moving to do it all online. It is not as comfortable, but something we need to get used to. For example, we are doing more online diligence for thousands of customers through online surveys.
- This was a very typical deal for our emerging fund, with special conditions. It is a technical product, so we could get very credible references from our own portfolio. It is also easier to grasp the risk remotely.
- It is a US$30M check, so it is a much larger check. So we are doing much more, I’ve met the CEO in the past six months, unfortunately not in person, but the team did it. Also, we are commissioning a deep consumer survey. We are also boiling the ocean as we know all the space and therefore we can be confident that this is the right bet.
What are the opportunities that can emerge, not being vulturistic
- Helen: Healthcare are doing really well in COVID-19 (ventilators, testing, telemedicine); Consumer internet, AI and deep tech are also doing well, not necessarily because of COVID-19, but in context of the US/China trade war that was not affected (import substitution). In the consumer tech side, there are also good opportunities, like the online education that Jenny mentioned. (there is no tutor that doesn’t know how to use online teaching now). Also online groceries are doing well: although things are normalizing in China, if people tried online groceries, it is likely they will do it again when the crisis come back. We are not fundamentally changing our investment thesis and strategy
Bridge rounds for portfolio. What is your approach during COVID-19 crisis?
- Helen: If the company has a term sheet that is about to close, the conversation is about a clear bridge to something. If the company doesn’t have a term sheet, everybody looks at each other, because no one wants to put the money alone. It is about how too put everybody at the same table. We do want to support our portfolio, specially if it is about liquidity vs. fundamentals. But we need to balance which in the portfolio we support with our reserves.
- Jenny: bridge loans are not a good way to approach it. We need to look at the fundamentals of the company (products selling, but they have a working capital gap to get from point A to point B, if it is more about supporting them). We usually support in the latter case and the terms are dependent to what we are bridging towards. If it is 1-2 months, we won’t do it. It needs to be 3 months or longer. If not, we also need to learn how to say no. It may be a product-market fit problem. But on the other hand, strong fundamentals, great CEO and great team, just a problem to resolve liquidity, we use part of our reserves, weighting against our long list of portfolio companies and those that we are willing to back. Also, you don’t make money with bridge loans, the 3-5x liquidation preferences are worthless in the long run, so it is about the fundamentals. It is important to have standardized terms to bring new investors (e.g. discount to the next round, interest rate), as it is an important signaling to the market.
How do you compare with the other down cycles?
- Jenny: This is different from others, the only crisis that is similar is SARS in 2003, but it was constrained to China (8 months). The difference here is that it is a global crisis, so in the past it was about managing locally, but now we know the world will be deeply impacted and it is much more globalized than we think. We also don’t know how long it will take. The dynamism and the uncertainty is much bigger, so we need to have two-week touch points to be adaptable, as things change every week.
- E.g. I have a robotics company 50/50 China/International. In Feb, I was bullish to go international, but in the past two weeks, I changed the direction to make it back to China.
- Also, we are acknowledging that the market is very interconnected.
- Helen: yes. I agree. The global supply chain is much more interconnected. I am also afraid that this will put the Chinese and the US ecosystem further apart. Just to close in a positive note, GGV did their investment in Alibaba during the SARS crisis in 2003. The company had a SARS case and changed its internal practices and emerged much stronger as well.
How to deal with term sheets pre-COVID-19?
- Jenny: we had a term sheet (it was TS, not documentation stage), so we renegotiated a stop date for another 60 days (in addition to the 60 days). It was very drastic.
- The second situation for a US$3M deal, we changed the terms into two tranches (2M, 1M) to put the additional 1M after six months. It is all about gaining time to evaluate if the investment thesis is still intact. So, for example, for R&D heavy investments not affected by COVID-19, we kept the terms and
- Helen: we sat with the entrepreneur to re-evaluate and be reasonable given the additional risk of doing an investment during crisis. I argued for lower valuation in a very transparent manner for the additional risk, and the CEO appreciated it
Will investing will increase, decrease or stay in the same in the next 6 months?
- Jenny: China stopped in Q1 but will go back business as usual in Q2/Q3; US Q2/Q3 will slow down drastically, even more than China, because burn rates in the US are higher;
- Helen: we will definitely try to keep up pace, but we will be cautious. For younger GPs that never went through a crisis, they will likely be scared and not do any investment, mostly because the amount of uncertainty we are facing in terms of the direct COVID-19 crisis but also the recession and unemployment.
8:00 AM PT: Decision-Making in Uncertainty
Albert Wenger, Managing Partner, Union Square Ventures
How do you feel?
If you’re in position to take risks on something new, this is a good time to take risk. E.g. USV invested in Twillio in 2008. There is a chance that this crisis will end as abruptly as it began, as you see the V-shape of the manufacturing output in China. That said, as US navigated the crisis more slowly, we are likely to suffer a bit more.
How to invest in uncertain times?
It is really important to discuss the fundamentals of uncertainty in VC investing. We need to understand the payout function, as the most you can lose is what you put in the company (if I put 5, I can lose 5, with caveats). A third of companies we invested are write-offs, so we need to find a company that can return the entire fund in your portfolio. If you have a company with 10% ownership (it used to be 20%, but now it is harder), you need $2B exit to make the returns of $200M fund. Convexity is important because some of the companies will do better during the crisis. Alt School, for example, grew 10x in the past month (I am not saying Alt School will be the fund returner, but they are much better now). Therefore, the construction of the portfolio is what will determine the return of the funds. If you understand it, you’re likely to not overreact and invest during the crisis, as the crisis is ultimately amplifying or changing the odds of write-offs and fund-returners.
How to invest remotely?
Being a NYC-based fund, we are already used to it. And there are many people that have been doing it for many years, so it is very possible. Also, the silver lining of the crisis is that some trends are going to be accelerated, like remote-work, telemedicine, move to distance education, the recognition with that is the importance of good broadband access. There are many positive trends that will be accelerated by this crisis, including the trend that fewer and fewer VCs insisting that you need to come to their offices to invest in them.
How are you supporting portfolio companies?
We e-mailed our portfolio in February to start preparing to work from home. We need to be ahead of the curve, so we gave good warning, so it is useless if we state the obvious. We also need to avoid being too generic and try to customize the advice for the context of each company. The only general advice is that, in crisis, we need to prepare CEOs to show leadership, e.g., what do you want to do if a team member gets sick and die from it. Because we have more distance from day-to-day, our role is to help them be as calm as they can be. A good investor is not pro-cyclical with the entrepreneur sentiment. We need to counterbalance their sentiment to help them navigate this well and provide emotional balance. Also, thirdly, our role is to be an emotional outlet for the CEOs: if they feel a lot of stress, they don’t want to appear stressed in their team and you should be there for them.
It is also important to go back to the fundamentals: you should have a theory/hypothesis/thesis when you invest. So, when a crisis hit, you can go back to the thesis and re-evaluate if the crisis is affecting fundamentally your thesis. Having a theory on why you’re investing in a company is immensely valuable in times like this.
What is the next trend you’re trying to anticipate?
I am trying to understand what the end of COVID-19 will look like. There are scenarios that will unravel rather rapidly or drastically. There were people who were ignoring all the signs that this would get much bad. Conversely, there are now signs that, once you get on top of it, you could get a return not to normalcy, but high level of productivity (context specific), even brick-and-mortar. I am spending my time to think about the next bounce of the ball. In the US, I think the risk of private bankruptcy and even with CARES act, we don’t have enough mechanisms to deploy this capital. So, with a high rate of SME bankruptcy, we will have a lot of trouble to emerge out of this in US.
Albert, thanks for joining us. In your talk at a previous NY module, you gave a fascinating talk about your thoughts on the future and the next Age of Knowledge. How is this pandemic changing your perspective on the shifting of scarcity (i.e., your World After Capital work)? And how does this make you think differently about your world view for now and for the future with regards to innovation and venture capital?
You can probably add me to the list of people that see this crisis confirming their pre-COVID-19 view. Much of what I write is the scarcity of human attention because we are letting it be allocated by the market. This is not a black swan event, it is a white swan as we knew a pandemic would happen (e.g., SARS, MERS). Although we knew, we didn’t prepare for it as we are allowing the market to allocate our attention (e.g., we underproduced vacines, tests, like the NPR story about the researcher that was developing a SARS vacine and didn’t get funding). Global warming resembles this one, but it is just slow moving. We should try to emerge out of this crisis with a better way to think about our attention differently, free of our attention out of the job loop (e.g. basic income).
Will you alter portfolio approach — hold funds earmarked for new investments to instead bridge current companies in the portfolio during times like this?
There were many funds that had no reserves for follow-ons, and I always felt it was a “good-weather” strategy that couldn’t survive a crisis. Even Seed funds should reserve a dollar for every dollar invested for the good-weather (follow on and increase in return) and bad-weather (save the best companies). If you have business that you have real conviction, but right now we cannot find anyone to see it, it is better to continue to support this one rather than find a new one (avoid the temptation to take a new roll of the dice, but double down). It is all about developing your conviction.
E.g., when we invested in MongoDB, the first release fell completely flat and we bridged the company because we had the conviction that what they were building something important. We also bridged Foursquare when they were transitioning from B2C to B2B, because we believed the importance of location to mobile technology. We saw the beginning of the B2B and could back it up. It not always work, e.g. Clickable, SMBs needed an extra console for advertising, but it didn’t pan out.
If you do have conviction, I am in the opinion that you should bridge instead of increasing the size of the portfolio.
How has this experience changed your fundamental world view and what you believe (if at all)? Does it make you question things about market/society/gov that previously you thought were unassailable, does it change how you think about investing?
There are amazing people in the world that want to help others. This crisis tend to reveal peoples, firms and governments nature. I am surprised of how many people rise to the situation, and some people try to abuse it. Society does need some form of mechanism (e.g., shame) to have people follow the rules.
A lot of people are excited with Twitter to prevent misinformation, but the challenge is that Twitter is not democratic. We are cementing their power of censorship. I don’t think this is a good development.
I’m curious to learn more about your hypothesis that this could end very rapidly and effectively. Even if the economy returns back to relatively normal levels of productivity, do you believe there may be long term effects that will be hard to reverse? In other words, as a friend put it, is this virus an “asteroid” that will destroy dinosaurs?
Some candidates for dinosaurs: e.g. traditional institutions of learning, who charge a lot of money for them to come to their campus and you can deliver it much faster and better online. Healthcare and education are more prone to disruption, and they are not new trends. A good “asteroid”, more like black swan, is not a good metaphor, because I think this crisis will accelerate trends and “asteroids” had much extreme consequences.
Any recommendations?
Develop your mindful practice. It will make you a better investor and a better human being.
#originally posted on Evernote#