Don’t play to win, play to survive, argues venture capitalist [Q&A]

In these tough times, entrepreneurs must execute a mind shift from “playing to win” to “playing not to lose”, as the key to the current period, will be survival. So, argues venture capitalist Clive Butkow.

In the new normal, many businesses will need to have unusually strong balance sheets and a compelling picture of the underlying business if they are to see much traction over the next six to 12 months.

Last month, Butkow, who is the CEO of Johannesburg based Kalon Venture Partners, said startups that are not venture capital (VC) funded and are looking to get VC funding, should have a minimum of 24-months’ worth of cash in the bank or secured revenue, in order to close investment (see this story).

The key to the current period, will be survival argues venture capitalist Clive Butkow

Today, in the following question and answer (Q&A) with Ventureburn, a usually optimistic Butkow details why he believes the pandemic will have a negative impact on entrepreneurs trying to raise capital.

Will fewer early stage firms get investment?

Kalon Venture Partners pre-dominantly invests in growth capital where the tech startup is looking to scale. We invest R1 and we expect to get out R1.50 — or if R1 acquired four customers then we want R1 to acquire seven customers.

I believe you are correct as the limited liquidity will still invest in companies that are looking for growth capital for their series A, B or C rounds.

These companies would have proven they are immune to the Covid scenario. I believe startups will really struggle to raise angel or seed capital.

It appears investors are still deploying capital, but we expect we will continue to see a major flight to quality over the coming months.

We are also operating in a selective market where good companies will need to be realistic on valuation. The short of it is the worst is still ahead. And the biggest unknown driving all of this volatility is how long the SA economy will be shut down.

How will Covid-19 effect VCs when raising of new capital?

We believe it is going to be more difficult to raise an African fund in the foreseeable future. We believe many limited partnerships (LPs) will not continue their commitments and will spend less on the VC asset class and specifically in emerging markets.

How will Covid-19 impact entrepreneurs trying to raise capital?

The virus will have a negative impact on entrepreneurs trying to raise capital.

There are a number of reasons for this:

1. Not being able to meet up in person: some venture capitalists will most likely not close a deal until they have met face to face with the leadership as well as the other team members.
2. There is far less liquidity in the market and venture capitalists are focusing more on triaging their current portfolio to assess which ones they will invest further capital rather than make new investments.
3. Meeting entrepreneurs. Investors generally have different criteria attached to the way they deploy capital. Typically, this will differ based on investment size, investment stage, primary market of the potential investee company, experience of founders, etc.

As a result of this, the way a startup rates along these lines determines how much importance is attached to in-person meetings.

So, while the ideal scenario will be to schedule an in-person meeting with a founder, we also know that investments will have to be completed virtually.

We believe that VCs need to be nimble enough to adjust to market and global realities, this is the expectation of their LPs who have given them capital to deploy, and doing otherwise will be in breach of their obligations.

At Kalon are actually in the process of evaluating some deals for potential investment. For us, the most important goal is that these startups checks all the boxes in our diligence checklist, irrespective of the virtual process involved in our evaluation process.

For the deals for which we had issued term sheets prior to the virus outbreak, we will continue with the deployment of capital.

We are taking extra precautions and not compromising on the quality and extent of our diligence and when we feel that something is missing, we request more video calls and for more documentation.

Simultaneously, we are corroborating all the information we receive with customers, potential customers, employees, and investors of the startup.

What about valuations and investment terms?

We have moved from an entrepreneur’s market to an investor’s market. Where entrepreneurs were kings and venture capitalists the beggars this situation has been reversed. Valuations are most definitely going to be reduced and terms improved for the VC.

With most publicly-traded tech companies down 30% or more this year, it’s not surprising that early-stage valuations are also getting dinged. From speaking to a number of local and global investors they expect valuations to drop between 10% and 40%.

It also comes as no surprise that this community of early-stage investors are focused on businesses that are both recession and Covid-19 resistant.

Those include telehealth and e-commerce companies as well as future-of-work platforms and infrastructure.

Businesses in the travel, hospitality, physical retail, restaurant, and real estate verticals will all face significant headwinds in the near term.

In the new normal, businesses in those categories will need to have unusually strong balance sheets and a compelling picture of the underlying business to see much traction over the next six to 12 months.

Survival is key

In a nasty downturn, you have to execute a mind shift from playing to win to playing not to lose. Only once you nail survival can you switch back to win mode.

Kalon is assessing each of our investee companies and trying to ensure they have a minimum of 24 months even if that means cutting heads as well as other expenses, eg rental.

Featured image: Kalon Venture Partners CEO Clive Butkow (Supplied)