- Haystack VC founder Semil Shah and Founders Fund general partner Keith Rabois both specialize in early-stage investing, although Shah typically writes checks earlier than Rabois.
- In a Talkshow broadcast, the two investors shared their firms' strategies for evaluating and investing in startups that may be struggling to land outside funding.
- Although VC firms across stages have claimed to be "open for business," both Rabois and Shah said they've dialed back and become more cautious with their funds.
- Shah told Business Insider that the firms that are cutting investment deals are only doing so when the deal is "opportunistic."
- Funding may see a prolonged dip akin to the 2000 dot-com crash, but Rabois speculated that it will not dry up entirely.
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Early-stage investing is sometimes more akin to gambling than to venture investing. The higher risks associated with backing an unproven product or service tend to pay off handsomely if the startup is successful. But in these times, that risk looks less appealing, now that the coronavirus-led economic slump has stacked the odds against most small businesses.
According to Founders Fund general partner Keith Rabois, early-stage VCs are indeed becoming more cautious, with only a handful of exceptions. But as Rabois told Haystack VC founder Semil Shah on a Talkshow broadcast in April, that doesn't mean term sheets have disappeared entirely. For example, hiring automation startup Workstream announced Thursday that Founders Fund led its $10 million Series A, and Rabois was joining the board.
"Post-crisis, all our competitors, but maybe one, have been much more cautious in pulling the trigger on new investments," Rabois said. "They are much more disciplined on valuation and slower on making decisions."
All in, Rabois said that he extended four term sheets over the last six weeks. Of those, the majority were either seed or Series A stage companies, with one Series B. Although the valuations on the deals were not made public, Rabois said that Founders Fund has started pricing in the prevailing tough conditions for the deals it does complete.
"Our approach at Founders Fund is, we will price in volatility and risk in the world, and our valuations will revert back to historical norms," Rabois said. "If the world, and founders, take a while to adjust, that's fine, but we are going to make offers we are comfortable with."
Founders Fund has a unique structure in which all partners can bring in a potential deal, but everyone at the table has to sign off for the firm to invest. Rabois said that one of the deals, the Series B, came in just under the wire before in-person meetings and international travel were completely scrapped.
"I'm not sure that investment would have been possible for us in the post-March world," Rabois said.
Getting investors on board with a founder they've only met remotely will continue to be a challenge, Shah told Business Insider after the broadcast had aired. In-person networking is something like the secret sauce of venture capital in that it lets investors get a feel for which entrepreneurs can hit it out of the park, and which raise red flags. It's a key component of investing at the earliest stages, as both Rabois and Shah do, because there typically isn't a working product or service that early on in a company's lifetime, so investors are betting mostly on the team itself.
"Those logistical and interpersonal components is where the process is most upended," Shah told Business Insider. "VCs are used to doing things in person and reading entrepreneurs in person. It makes sense. If I am writing $10 million to $20 million checks, I want to have dinner with the person."
Many founders see venture capital as a black box operation, Shah said, and are easily overwhelmed by the different opinions circulating on sites like Twitter. That "firehose," as Shah called it, can sweep founders into a sense of complacency if they believe all firms are still writing checks at the same rate they were before, only to find out in six or nine months that it simply isn't the case. According to Shah, part of the benefit of hosting his conversation with Rabois publicly was to show founders what is really going on in their world.
"I wanted people to understand how VC firms are behaving," Shah said. "They are saying it in different ways, but they won't write a check right now unless it's opportunistic or really needed. It's intuitive and obvious, but Keith will say it and be direct about it."
Rabois didn't disappoint. During the broadcast, he confirmed that one of the companies he funded was the first to pass muster even though he and the Founders Fund team had never met the entrepreneur. He declined to identify that company. He said that, although slower and more deliberate, the deals are still happening and will continue to happen. They just might look a little differently than they had in the last decade.
"This reminds me more of the 3-to-6-month 2008 blip in terms of impact on venture financing but I suspect it converts into the 2000 to 2003 era where it is extremely difficult to raise money and it's very rare to raise a substantial growth round," Rabois said in the broadcast. "Valuations will correct back to historical norms, and when I say historical it's not 2010 but more like 2005-2008."
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