Canadian VCs remain cautiously optimistic in face of COVID-19 disruption

    All the world markets including the Toronto Stock Exchange suffered huge losses as concerns over COVID-19 coronavirus begin to increase in Toronto. Steve Russell/Toronto Star via Getty Images

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    The “Black Swan” note Sequoia Capital sent its portfolio companies last week amid the fallout from the COVID-19 pandemic warned of a challenging new reality for startups—one that involves falling cash and revenue flows, unprecedented supply chain disruptions and a workplace culture transformed by social distancing. 

    While Canadian venture capital investors took heed of Sequoia’s warnings, they’re striking a more optimistic tone. They share a common belief in the resilience of the country’s founders and CEOs, and think Canada’s innovation economy will remain on track as long as its best companies are fully funded and ready for what comes after the coronavirus outbreak.

    Talking Point

    The Logic interviewed eight of the country’s leading VCs this week, as markets crashed and the World Health Organization declared COVID-19 a pandemic. Though they’ve taken stark note of a Sequoia Capital memo warning companies to adapt in order to survive these turbulent times, they struck a more optimistic tone, urging founders and CEOs to stockpile on capital, develop profitable long-term business plans and be resourceful in their fundraising abilities.

    “I think we can all play a role by injecting a bit of confidence and optimism into the ecosystem wherever and whenever possible,” Panache Ventures’ Patrick Lor told The Logic. “We’ve also learned from previous recessions that tough economic conditions can drive innovations and cost efficiencies, so there’s good reason to believe that we come out stronger than ever.” 

    The Logic interviewed eight of the country’s leading VCs this week, as markets crashed and the World Health Organization declared COVID-19 a pandemic. While they echoed Lor’s confidence, they warned Canada’s CEOs and founders need to show they have steady hands, the resourcefulness to use their existing capital to adapt to delays in revenue and investment, and business plans showing they can be profitable once the chaos subsides.

    To be sure, many Canadian VCs echoed some of the Sequoia’s arguments, particularly about the need to adapt quickly. Boris Wertz, founding partner of Version One Ventures, sent a memo to his founders a week before Sequoia with guidance that foreshadowed some of the points in the Black Swan note. He advised companies to reduce “surface area” for their employees—meaning working from home, cutting down on in-person meetings and restricting big events and travel—and to prepare for a Plan B, “especially if your burn rate is high and you need to fundraise this year: consider cost-cutting to get to profitability and acceleration of fundraises.”

    Janet Bannister, managing partner of Real Ventures, said her firm sent a note to its portfolio firms’ founders, too, along with a templated human resources policy: “We encourage you to think carefully about how COVID-19 will affect your business and what adjustments – if any – you should be making at this time,” it advised.

    “What is particularly challenging about this situation is that it is not only an external business challenge but this also presents a potential risk to all of their employees and their employees’ families,” Bannister told The Logic. Companies need to do “a sensitivity analysis to understand the business impact under various scenarios and the implications for how they should respond.” 

    But adaptability isn’t the only challenge for Canada’s innovation economy, which has many young founders who may not have experienced an economic crisis of this proportion in their lifetime. However resourceful they are with their existing capital, it’s possible some simply don’t currently have the balance sheet to contend with the challenges they now face.

    To that end, Relay Ventures has advised its companies “to conserve cash, cancel or defer capital expenditures, reduce expenses and draw on available lines of credit and/or quickly complete financings already in process” in preparation for a downturn. (Relay Ventures is an investor in The Logic.)

    Radical Ventures’ Benji Sucher sent the firm’s portfolio companies a memo on March 12 on how to weather the crisis. In an interview with The Logic, Sucher said, “There’s a lot of opportunity from a founder’s perspective to use their capital more intelligently when they think about purchase and growth, understanding that their next sales meeting face-to-face might be delayed, that their next purchase from a customer might be delayed and their next booking to help them move through the funnel also might be delayed.

    “At the end of the day, the very revenue and cash flow they expected to receive this year might be in fact delayed.”

    Companies’ valuations are certain to take a hit, said Round13Capital’s Sanjiv Samant. “Many private companies will inevitably seek to finance this year, either as a result of their burn rate being higher than expected from lower revenue [and/or] productivity if not from simply a prudent risk management perspective to take more cash on to extend their runway,” he said. 

    Lor agreed, noting that “companies will now have to have stronger balance sheets to survive this downturn, which means they’ll have to raise more money than previously budgeted.”

    Quantius’s Lally Rementilla believes fundraising will slow down as investors reassess their portfolios “and then rebalance and course correct.” As a lender, Quantius focuses on downside risk mitigation more than most, so the slowdown may be the only major factor in changing its investment process. “In this scenario, we will be more diligent in understanding a company’s chances of raising equity on time.” 

    But there is opportunity, too. A weak Canadian dollar may attract more international investors. There’s a lot of “dry powder” in the private equity and venture capital markets. IP-rich companies may thrive in these turbulent times, as could AI firms that come up with innovative solutions that can be commercialized in a post-coronavirus business environment.

    In the best-case scenario, Peter Hall, Export Development Canada’s chief economist, predicts that the negative economic effects of COVID-19 will be contained within the first half of 2020. Any lost economic activity will be recovered as the global supply chain resets. 

    “If (the innovation economy) can produce a cost-effective production solution that brings the supply chain in-house, it would find a post-coronavirus market more receptive than before,” Hall said.

    “This is the time where we can show how our companies have created moats around their businesses that make them essential to their customers,” Rementilla said.  

    Thomas Park, vice-president of operations and strategy at BDC Capital, said to prove that, Canada’s innovation economy needs to be “more aggressive” and attract investors. 

    “It’s a good time to be in Canada because we have a mechanism to be counter-cyclical,” Park said, attributing that to funds like the $450-million Venture Capital Catalyst Initiative—a program designed to make more money available to Canadian firms—which could help startups build traction in tumultuous times.   

    “I think tech overall will rather benefit from this crisis,” Wertz said. “More processes will be moved online, more things digitized, [working from home] will be more broadly adopted, etc. And Canada’s innovation economy is very well positioned to benefit from this trend.” 

    “We are not changing our investment approach…. In fact, we just issued a term sheet for a new investment.”

    CORRECTION: This story has been updated to correct Boris Wertz’s title. 

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