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COVID-19 creates long and winding road for startups seeking investment

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COVID-19 creates long and winding road for startups seeking investment 1

By Jayne Chan, Head of StartmeupHK, Invest Hong Kong

Countless technology and other companies describe themselves as innovators, disruptors or game changers, or maybe all three, and sometimes that’s true. But none have had quite the disruptive force of COVID-19 which has flipped work and life habits upside down and sucked so much oxygen out of the global economy. The impact will be lasting: many of those new habits are here to stay.

Yet, while a recalibration of lifestyles and business processes is perhaps overdue – and to be embraced given it’s happening anyway – the change presents huge challenges for startups and new businesses that were on a growth trajectory prior to the pandemic. Few would deny that opportunities exist amid the disruption, but the challenge right now is to survive the crisis intact.

The global economy this year will see its biggest contraction in decades. The World Bank projects global gross domestic product to fall by 5.2% this year,[1] with advanced economies shrinking 7% and emerging economies 2.5%. It forecast East Asia and the Pacific to grow just 0.5% this year, down from 5.9% last year. These forecasts assume the markets will return to somewhere near normality during the second half of the year.

Despite all the economic murk and gloom, there are signs that a post-COVID bounce is likely. The World Bank predicts economic growth of 6.6% in East Asia and the Pacific in 2021.

Some business sectors fare better

Looking around, it’s reasonable to anticipate a relatively speedy recovery. In a few business sectors, such as healthcare and telemedicine, e-commerce, fintech, home delivery and food retail sectors, there are companies that have fared better. In some instances, the situation has been transformational in a positive way.

In fintech, for example, global investment actually rose year-on-year in the first half of 2020, according to Accenture,[2] up 3.8% to US$23.1 billion from US$22.3 billion, albeit with the help of COVID-related government loans in some markets. Asia-Pacific saw a sharp rise driven by China and Australia. In the first half, China’s fintech market grew 177% year-on-year to US$2.3 billion, while Australia’s grew 189% to US$1.2 billion.

Resilience is clear to see, but businesses face huge challenges. From a startup perspective, within weeks of the COVID-19 outbreak, many companies went from being solid-growth enterprises, possibly looking to raise money, to ones simply trying to stay afloat.

Debtor books have grown massively as companies stop cash going out the door. Many well-run companies have customers who may not be cancelling, but they are also not paying as fast. For such companies, it becomes a cash issue rather than a fundamental underlying business one. The reality is that businesses are ensuring that every penny going out the door absolutely needs to – so payment terms get stretched. It’s understandable, but it’s problematic if everyone does it.

For startups seeking to work their way onto the fundraising ladder, the process typically starts with an initial pre-seed and/or seed round, which then moves on to Series A to B, C and onwards as needed. The funds usually come from angel investors, accelerators or venture capital firms, in return for an equity stake. Even at the best of times, pitching to get on the first rung of the ladder is perhaps the greatest challenge.

Bar for investment higher as company valuations drop

Advice for many prospects looking at fundraising, certainly during the first wave of COVID-19, was to do nothing except focus on survival. For investors, a business that weaves and navigates its way through the crisis, or even take advantage of the pandemic environment to flourish, is likely to resonate.

Even for those companies that have fared better in recent months, barring an utterly compelling reason to raise funds, now may not be the ideal time. It’s clear that the bar for investment has gone up and company valuations have come down, neither of which is a surprise given higher risk profiles at present.

For companies that are well known to investors, such as Grab, Lu.com, Airwallex or WeLab, fundraising is more manageable. And for slightly smaller but relatively new companies, there are plenty of examples of recent success attracting fresh investment, often through existing investors.

Jayne Chan

Jayne Chan

But for smaller, newer companies, not being able to do face-to-face pitches creates much more of a challenge – after all, most funds like a boots-on-the-ground physical interaction before putting money in, particularly if the sums are large.

Despite all that, for new businesses planning to seek funds down the line, there is no harm warming up investors. Having the right conversations now makes sense and would help a startup to hit the ground running when the pandemic abates. The conversations should include ones with government funding organisations. For an investor, matching government funding is attractive because of the higher startup success rate.

Pandemic drives consumers and businesses online

Thanks to the pandemic, people are now far more willing to go online for all manner of transactions. Working remotely from the office is now commonplace, with work hours more flexible.

This trend among consumers, healthcare professionals and office workers has become more entrenched – more retailers are going online, while companies rethink their office space needs. This extends to investors, many of whom initially sat on their hands expecting COVID-19 to quickly pass by. They quickly adapted when it became clear coronavirus was going nowhere fast.

Quantitative easing and low interest rate policies by central banks, along with a boom driven by the lockdown – appetite for online entertainment, financial services, communications, healthcare, shopping, etc. – spurred fresh demand for tech products, pushing share prices rising to record highs. This created an attractive environment for investors to seek fresh investment opportunities.

A consequence of widespread digitalisation is that software, e-commerce and, more broadly, digital startups have an advantage in the competition for funding. An ability to do business both face-to-face and remotely makes such businesses less vulnerable to other trade pitfalls and therefore more attractive for investors.

Conversely, it’s harder for hardware startups at a time when global trade is weakening. They have to consider whether production costs and the markets they promote will be affected by such issues as tariffs or people flow. This type of startup is likely to have access to fewer financing opportunities.

It may seem obvious, but it’s of paramount importance for startups seeking funding to be clear about what they are looking for from investors. Are they simply injecting capital as a passive investment hoping for a return, or are they looking to create synergies to help develop the business? Startups should consider what resources investors can bring to the business besides capital.

These are testing times. However, founders of startups need to stay positive and true to their mission and vision, and why they started the companies in the first place. After all, that’s their value proposition.

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