The Future Of Money: An Investor’s Guide To VC Funding During Recession

When I think about a recession from an investor’s point of view, two words come to mind: – risk and opportunity. 

The world is edging towards a global recession. As per the new study by the World Bank, multiple historic indicators of global recessions such as a sharp decline in consumer confidence, a slowdown of the world’s three largest economies—the United States, China, and the euro area, and others are showing red flags.

In pre-recessionary conditions, some investors prefer to take extra precautions when managing their portfolio and picking up new assets. They tend to lean on the companies with strong balance sheets, good cash flow and non-speculative, in the industries which tend to do better than others during recessions – food, energy, utilities, healthcare, and logistics. Which is typically bad news for non-mature startups, which are slower to generate returns, more speculative and generally risky.

Venture capital in economic turmoil

Global VC market played to the fore. According to the ‘State of Venture” report by CBInsights, startups have raised only $108.5 billion in venture funding across 7,651 deals, which is down 23% QoQ – the largest decline in the number of deals (and the second largest decline in money) in a decade. 

The ones most affected are the later stage startups. As VC money is getting tighter during the recession, investors inevitably become more picky and prefer to scale back the offers. Hence, Q2 saw a -31% decline in $100M mega rounds and -43% YoY drop in the number of new unicorns – a 6-quarter low. A -16% QoQ drop in total exits also indicates that some investors hope to wait out the storm.

Early stage also showed a slowdown, falling by -18% QoQ, but the seed funding remains strong. Historically, startups at earlier stages had less concerns about finding initial VC funding in comparison to growth stage companies seeking follow up rounds during economic turmoils.

In a nutshell, should the world fall into a global recession now, the VC market meets it more cautiously than ever before. Yet, that doesn’t seem right. Unlike the public market with risk aversion as its bread and butter, a certain degree of risk is not new for VCs – at the end of the day, only 80% of startups survive through the first year. So here’s why investors should not turn their eyes away from the private companies during recession – and instead, look out for the opportunities.

4 reasons to invest in startups during recession

Investing in startups is a non-obvious, yet a powerful strategy before and during the recession – mainly due to those reasons:

• Access to lucrative deals

Economic turmoil inevitably impacts the valuation of startups. With fewer investors willing to write large checks and decline in a number of mega-rounds, it gives an opportunity to join a funding round of a promising project at a lower rate. And while undervalued by the market now, some of those startups might skyrocket after proving their resilience during the recession.

Startups have a strong benefit over the large public companies in the tough economies: arbitrary valuation that changes way less frequently. An average recession lasts about 15 months, while the lifespan of a startup from VC funding to exit can be considerably longer. Recession or not, successful investors tend to avoid buying and selling assets based on cyclical economic shifts, and instead focus on their long-term investment goals.  

• “Safe harbor” against inflation

While public markets continue to shrink, there is record dry-powder to deploy in the private markets, leaving enough potential for growth beyond current inflation levels. With enough prediction power – an ability to generate predictions with high maturity rate – VC market becomes the “safe harbor” against inflation.

Startups are naturally founded to help solve problems that no one else could – or didn’t do efficiently enough. With new challenges brought by the recession and related behavioral changes, there is more appetite to fulfil some critical needs – like energy, healthcare, or groceries. In fact, Whatsapp, Venmo, Uber, Instagram and Slack are only a few in a plethora of successful startups founded during the 2008 recession to provide solutions to the most burning problems of that time. The world relying on private companies to find unprecedented solutions might give them a strong boost for growth.

While the economic turmoil is indeed a great time to invest in startups due to the long-term planning, agility and adaptability, it’s important to choose the right strategy to safeguard the VC investments during a recession. 

How to invest in startups in recession

Venture funding is a highly profitable investment if the strategy is chosen right. 

• Invest in future ecosystems

It’s imperative to look not for the quick returns in existing markets, but for the high potential solutions at the verge of existing and new niches. For example, both SpaceX and Momentus address a multi-billion space tech market, where private companies have only scratched the surface of the opportunity. Or a Content Driven Mobility market where WayRay is growing: once embedded in a critical mass of cars, those solutions will create new markets and revenue models for content creators, advertisers and all sorts of businesses.

• Rely on data and technologies

For any investor, it’s key now to identify a startup with a business model that makes them more resilient to an economic downturn. However, the VC market is largerly driven by non-public insight: there are no disclosure requirements or free access to information. Advanced prediction methodologies developed and used by reputable VC funds help gain access to insights, manage uncertainty and pick the right startup to fund.

• Choose the right way to invest

The shares of some companies may only be available through a direct PE/VC deal or secondary market. Investing in early stage startups directly makes it easier to agree on valuation and T&C’s – and potentially grow a new unicorn. However, this option requires an in-depth understanding of the market and technologies, ability to evaluate due diligence, and hence it is more risky. 

Alternatively, it is possible to buy on a secondary market via SPV through venture funds with access to rounds. This option requires passing a KYC, but it’s typically easier and more reliable.

To sum up: there is little to none reason to avoid investing in startups before and during the recession. On the contrary, as proved by history, the current economic situation provides some great untapped opportunities in the private market with a long-term investment focus. Those projects that will show resilience amidst the pandemic have chances to become the next Ubers and Slacks in the next decade.