The resurgence of Covid-19 across Europe continues to make headlines, but as summer draws to a close and with schools reopening, the UK is doing its best to get back to normal. For those covering the VCT market, it seems like just the other day when RNS feeds were reporting the publication of revised NAVs, and supplementary prospectuses as VCT managers prepared to close fundraising for the 2019/20 tax year. Perhaps it is a side-effect of the lockdown that it seems so recent, but that was back in March and April and we have been living with the effects of Covid-19 for almost six months. With the 2020/21 VCT fundraising season already upon us, in this latest article we outline some of our thoughts, more generally, about venture investments as part of a broader portfolio.
Many comparisons have been made and will likely continue to be made about the difference between the 2008/09 Great Financial Crisis ("GFC"), and the current economic recession. While we will not explore this in detail here, there are a few areas which are particularly relevant for venture investing. For one, the current crisis has been driven by a health pandemic and the resulting impact of lockdowns, social distancing, and the significant behavioural shifts across society. As a result, it presents a completely different set of problems for fiscal and monetary authorities in comparison to the GFC, where recessionary impacts were driven by a liquidity and credit crunch. Perhaps one of the biggest risks to venture investments amidst a crisis is the potential for a slowdown in fundraising, and therefore, difficulty in accessing capital to fund continued growth and development. However, in the current crisis, there has not been any significant withdrawal of liquidity, at least not to the extent seen in 2008/09 (yet!). Rather, there has been a change in consumer behaviour.
Nonetheless, it must be acknowledged that there will likely be some start-ups that cannot source the working capital they require to survive a recession. Naturally, for some of the companies that fail, this will be down to with weak management and poor cash management – eventually problems that will cause a business to fail in any environment. Companies which are slow or unable to adapt, and which have exposure to particular areas of the market (notably those subject to changes in discretionary spend), will be most at risk.
Given the structural shifts in behaviour, one of the most obvious being the ability for an entire population to work from home, there have been several externalities, both positive and negative. In such an environment, the most successful start-up companies will be agile, led by strong founders and backed by experienced funders. With the right formula, these companies have the potential to adapt to the changing environment much quicker than larger, more established competitors. We have seen this already, with many investee companies across venture portfolios pivoting product offerings (some more successfully than others), and the channels through which they deliver their product or service, and through this finding new ways to continue their growth.
It is also important to remember that venture is a long-term investment, up to 10 years and beyond: venture investments need to be able to survive the market cycle. While there may be some impairments to valuations in the near term, and some companies may struggle to survive the impending recession, an astute venture investor will be able to see the longer-term investment case. These investors will see through the recession and will provide funding to those companies which are seeking to provide a solution to a longer-term problem. They will be able to identify the longer-term drivers of growth and will be in a position to help these companies navigate the short-term headwinds.
We cannot ignore the fact that the UK is entering into a recession, the depth and extent of which is unknown. Coupled with the ongoing uncertainty about the "new world" in which we now live, it should be expected that investors will take a more cautious stance with their investment portfolio. Further we would reiterate that venture investments are risky, with a high chance of failure. However, assuming the adequate level of due diligence is undertaken, and given a sufficiently long investment horizon, consideration should still be given to early stage investments (including EIS and VCT), despite the current economic environment.
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