The COVID-19 pandemic has battered industries around the world, but one sector's prospects aren’t so bleak: venture capital.

Startup backers—and private-equity managers in general—say that half of their portfolio companies haven’t been harmed by the coronavirus that stalled the economy in March, according to two new surveys by Paul A. Gompers, the Eugene Holman Professor of Business Administration at Harvard Business School. Only about 10 percent of companies in this often unpredictable industry have been severely affected.

Despite the economic uncertainty, 91 percent of venture capitalists expect their investments to outperform major equity indexes going forward, and they’re continuing to fund new endeavors.

“It’s sort of the opposite of doom and gloom,” Gompers says. “We were surprised by how relatively unaffected the venture industry was.”

In collaboration with the National Bureau of Economic Research, Gompers teamed with Will Gornall of the University of British Columbia, Steven N. Kaplan of the University of Chicago, and Stanford University’s Ilya A. Strebulaev to survey more than 1,000 venture capitalists at 900 firms from late June to mid-July.

“The bulk of VC investors are looking to do new deals. They’re just sitting on a ton of money.”

During that period, global daily deaths had topped 9,000 for a second time as infection rates were soaring across the Americas. Almost all of the world’s 10 largest economies were contracting.

Despite the widespread pain, venture capitalists surveyed—who collectively manage $340 billion in assets—said they expected their funds to prosper. However, two-thirds acknowledged that investing had slowed. During the first half of 2020, they invested at 71 percent of pre-pandemic levels, a rate that they expect to climb to 81 percent by the end of the year.

Venture funding in a socially distanced world

Discouraged entrepreneurs shouldn’t put away their pitch decks yet. For one thing, funding commitments are still outpacing those of past periods of economic distress, the researchers say. US-based venture capital firms also entered 2020 with strength after raising $46.3 billion in 2019, the industry’s second-best year of the past decade, according to the PitchBook-NVCA Venture Monitor.

“The bulk of VC investors are looking to do new deals,” Gompers says. “They’re just sitting on a ton of money.”

Perhaps reassuringly, a far more basic factor has been holding back investment: remote work. Lockdowns and rising COVID-19 cases prompted many venture capitalists to literally head for the hills, decamping to vacation homes in Wyoming and Idaho. Even with its close ties to Silicon Valley and emerging technology, the loss of in-person pitch meetings has stymied an industry used to schmoozing.

“Informal networking is so critical to deal flow,” Gompers says. “And of course, less time is being spent on networking because you’re not physically together.”

The pandemic might also delay initial public offerings, forcing venture funds to hold investments longer than planned. To ensure smooth exits, many venture capitalists have redirected their time from deal-making to shoring up portfolio companies.

Given these conditions, Gompers says that startup founders should expect:

• Longer pitch and review processes. While venture capital firms will need to deploy near-record amounts of capital, the due diligence process will take significantly more time, Gompers says.
• Potentially less favorable terms. As the pandemic grinds on and funding becomes potentially riskier, venture capitalists might assign lower values to startups and seek larger equity stakes.

“The valuations might not be as high as they would have expected, but there's still money there,” Gompers says. “There are still opportunities for those with really great companies or really great ideas.”

Private equity’s less rosy outlook

Venture capital’s resilience contrasts with the rest of the $4 trillion private equity industry. Even though COVID-19 has hurt a similar percentage of companies backed by private equity and venture capital, returns on traditional private equity portfolios will likely be worse this year, Gompers says.

Like venture capital, the US private equity industry entered 2020 on solid footing, with a record $2.5 trillion of capital to invest, according to Bain & Company. However, the need to triage vulnerable portfolio companies and ongoing uncertainty about the pandemic might hinder managers’ ability to find new deals, the researchers say.

“The private equity firms have truly had to roll up their sleeves and become very, very active in their portfolio companies,” Gompers says. “And there's only so much time to spend in a given day.”

Gompers, Kaplan, and Georgetown University’s Vladimir Mukharlyamov reached out to 200 private equity managers from firms overseeing more than $1.9 trillion in assets during July and early August. They found that 92 percent of private-equity managers were interacting with portfolio companies every week during the pandemic, compared with 26 percent among venture capitalists. Another 6.8 percent were working with companies daily versus 2 percent among venture capitalists.

Will the intense interaction make a difference for private equity? It’s hard to say, but the hands-off nature and low expectations of venture capital firms, which invest in less established companies, might serve them well during these turbulent times.

“In venture capital, a third of the companies you put money into are just going to go belly up,” Gompers says. “But maybe 10 or 15 percent of your companies will go on to make five or 10 times your money.”

About the author

Danielle Kost is the senior editor of Harvard Business School Working Knowledge.

[Image: Hiraman]

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