In June, Cambridge Associates hosted a webinar entitled The Path Ahead: From a Bear Market to the New Normal. In this discussion, Deirdre Nectow, Head of Global Business Development and Client Service spoke with Co-Head of US Growth and Venture Investing Theresa Sorrentino Hajer and Chief Investment Strategist Celia Dallas about what the path to recovery may look like as countries gradually re-open their economies, and how consumers and businesses may change as a result of our experience in managing through this turbulent market period. Theresa provided her insights on the venture capital industry in particular. An excerpt of her perspective is below. You can also view the full webinar here.
Theresa Sorrentino Hajer: Despite the bullishness on the tech sector in general, venture capital and private equity managers we’ve talked to on average are sober, and downside planning is robust given the uncertainty regarding the shape and length of the recovery.
TH: In general, managers have evaluated their portfolio companies’ businesses in two ways; 1) short term/immediate impact of COVID and 2) long-term durability.
VCs have worked with their portfolio company management teams to re-budget expenses, preserve cash, and avoid coming back to market to raise equity to fund their businesses if they can. The VC market has been well capitalized over the past several years and, as a result, only a small percentage (less than 20% of portfolio companies in a fund) have less than six months of cash runway. The majority have 12 months or more of cash after adjusted operating budgets.
That said, we are worried about early-stage companies raising capital and late-stage valuations, which have hit historic highs the last couple of years. On the flip side, for those companies with durable business models, some managers are playing on the offensive, and leading internal rounds to increase their ownership in companies or pursue add-on acquisitions given growth prospects post a recovery and market tailwinds.
TH: The rapid acceleration and adoption of digitized business models is certainly one major change. There is an increasing notion that every business needs an omni-channel strategy. We saw this in retail with e-commerce and in financial services with digital payments. One estimate indicates 3.8 billion people are using e-payments for their personal expenses. This is tremendous global adoption.
Tech investors have been anticipating this digitization for years. Many have said COVID-19 has accelerated five-to-ten year trends to a matter of months. I think this notion of every business having an omni-channel strategy is here to stay. For example, we’ve heard lots of stories about big employers who are talking about permanent work-from-home positions and transitioning to a cost-efficient and flexible hybrid model. We “knowledge workers” have been fortunate to navigate this shift well.
With regard to private companies, and particularly start-up companies with durable business models, CEOs have adjusted operating models to continue to invest in R&D, so they are in a position of strength coming out of the recovery. They are capitalizing on the growth of global entrepreneurialism and tech talent—that is also a clear market change. Some Bay-Area tech start-ups are moving engineering into other markets and, importantly, outside the US. It is not clear if moves will be permanent, but a distributed work force could prove to be more efficient, and access to a wider pool of talent could reduce costs. If the changes are permanent, there will be impacts on big tech hubs that perhaps could help make the sector more inclusive, which is a much needed change.
TH: A durable investment trend we see is the convergence of technology investing and impact investing. Perhaps this crisis has led to a tipping point. High-quality talent continues to flow to GPs and the underlying portfolio companies in this space. We observe this repeatedly. Seasoned operators, entrepreneurs, and investors continue to be attracted to mission-driven organizations with a focus on real solutions and positive impact. This trend has not wavered in the current environment so far, and the need and investment opportunity only continues to grow.
Resource efficiency is a broad investment opportunity, such as energy efficiency investments in construction tech and data center management. Healthcare is another area. For example one company repurposes catheters for electrophysiology procedures and another buys and sells used medical equipment.
Many of us have had a front row seat in seeing the overnight adoption of e-learning platforms and telehealth; these are not new models but the crisis has driven adoption overnight. But the healthcare and education industry face regulatory risks and capital intensity for large-scale and long-term adoption. For e-learning to be universally accessible, digital infrastructure improvements are required in all regions, particularly in rural areas and even some cities.
Telehealth is also having a moment as many healthcare providers have shifted their business from roughly 10% to 90% telehealth. But the long-term durability of virtual healthcare is subject to reimbursement risks as well. A shared incentive structure across constituents (cost savings, clinical success, and changing consumer behaviors) is promising. I don’t think there will be complete shifts to virtual healthcare and learning, but this hybrid strategy to delivering healthcare and education is indeed a durable one, as are tech enabled, commercially viable business models aimed to serve a host of opportunities (and societal needs) like workforce development and financial inclusion.
In general, we expect that there will be “winners and losers” in this crisis across all sectors. Some of the attributes of winners will include diversified distribution channels for the sales and delivery of products and services. Criticality is also a factor; for businesses, this means mission critical products and services, such as cyber security technology to enable remote work management. Other key aspects will be businesses that address and meet changing customer behaviors and needs. On the flip side, examples of losers could be those businesses that rely on “normal” operations, like travel and hospitality, or those whose shortcomings have been highlighted, like co-working environments or event-driven business models.
TH: Everyone is struggling with this right now, particularly with new relationships or new firms. If limited partners have an existing relationship with a manager, virtual diligence is doable. For new relationships, it is really challenging for limited partners. It is extremely difficult to get a real feel for a manager’s organization and its culture in a virtual environment; one-on one-video conferencing is helpful in some regard, but team dynamics over video calls are easily misinterpreted or just unclear.
I’ve had many discussions with LPs around these challenges. Where it has worked, it often requires extra video interactions and extensive, additional referencing. While this referencing is key, some have raised the important concern that COVID could mean a step back for diversity in the PE industry, both in terms of managers and underrepresented founders as LPs and investors focus moreso on existing relationships.
TH: In discussions with emerging managers, we have encouraged them to focus on raising what they can from their existing relationships and to do some initial deals to give potential LPs some visibility in the types of deals they can do, even if it’s sub scale. Our message to them is this environment may require some adjustments to their plan. In providing this feedback, it also gives us some insight into the manager in terms of their response—do they respect the challenge LPs are in, are they willing to do this interim step in building an LP base, or are they inappropriately inpatient?
It’s certainly a difficult environment, but we are focused on using this time as best we can to develop relationships, be intentional, and to quote one manager, “have a prepared mind.”