VCs say that they're waiting for the 'new normal' before making big new startup investments: 'Whether they admit or not, everybody's in a little bit of a wait and see period'

• VCs are preparing themselves for "a new normal" as the coronavirus outbreak continues to push people into quarantine and batter markets.
• Deal flow, which has already dropped 12% in the first quarter compared to the same timeframe last year, is expected to slow down even further as investors expect the coronavirus crash to worsen.
• And VCs warn that startup funding could dry up further as their own investors, known as limited partners, grow more reluctant to fund newer, less-established VCs.
• "Whether they admit or not, everybody's in a little bit of a wait and see period - just trying to figure out the new baseline," said Jeff Morris Jr., sole general partner at Chapter One Ventures.
• And while VCs are still keeping an eye out for any potential game-changing startups that may emerge out of the downturn, uncertainty about the coronavirus itself is causing most to wait for the dust to settle before taking any action.
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Two weeks ago, Michael Jones, the CEO of LA-based startup accelerator Science Inc., thought that the coronavirus panic was probably exaggerated- business would have to continue as usual sooner rather than later.

"It's hard to believe that the US economy will come to a full-blown stop," he told Business Insider at the time.

By the end of last week, though, his tune had changed, as confirmed coronavirus cases in the US spiked, and the markets remained in turmoil. As companies of all sizes began mass layoffs, Jones echoed the sentiments of many in Silicon Valley and beyond.

"We may not return back to normal - we'll likely find a new normal instead," Jones told Business Insider last Friday.

To that point, funding for private companies has already dropped 12% in the first quarter compared to the same timeframe last year, according to the research firm CB Insights- a possible sign that the VC industry is taking a wait-and-see attitude before writing any big checks.

"Whether they admit or not, everybody's in a little bit of a wait and see period - just trying to figure out the new baseline," said Jeff Morris Jr., sole general partner at Chapter One Ventures.

The idea, it seems, is to see if the current tumult changes the underlying market conditions. For the last several years, startups have enjoyed skyrocketing valuations, propelled by mega-rounds from investors like the Softbank Vision Fund. The current state of market tumult, and the aftermath, may bring both valuations and deal sizes down.

"We're waiting to see what's going to happen, waiting to see where the market shakes out, and waiting to see how that potentially impacts post-money impact," Semil Shah, the sole general partner at Haystack VC and a partner with Lightspeed Venture Partners, explained. "This is already an environment where valuations have been too high."

In the interim, VCs are pulling back on their funding strategies, even as they reassure their LPs - and start to keep an eye out for any emerging companies that come out as winners in whatever the "new normal" turns out to be.

Pulling the brakes on deals

Shah says that he hasn't completely stopped offering term sheets; he closed a new investment back in February and committed to two new deals in the past month. But he cautions that most VCs are unlikely to hunt and take on new deals right now - so any deals announced now were probably closed before the coronavirus crisis in the US worsened.

"A deal that was in process already would probably get done, but things should be read very skeptically," Shah said.

And as Shah previously told Business Insider's Melia Russell, institutional funds might be more inclined to spend their reserves funding and reinforcing their existing portfolio companies- especially those in the travel and hospitality industries, which have been dealt crippling blows by the coronavirus outbreak.

Reassuring partners

VCs also caution that a drought in funding could also be instigated from further up the pipeline.

Over the past ten years, the VC industry has diversified far beyond traditional venture funds. Venture capital is now crowded with investors wielding different levels of financial firepower - angel investors and microfunds, corporate venture capital, and mega-sized funds, to name just a few.

But as the coronavirus crisis hits all industries, VCs say that their investors, known as limited partners, are hurting. The money managers behind pension funds, endowments, and other investors may chose to shy away from risky startup investments amid broader market uncertainty.

Consequently, less-established venture firms may find themselves under more pressure to hold back funding, investors say - assuming their LPs don't jump ship entirely, and go to larger, more established VCs for safety's sake.

"I'd say there's a lot of fund managers who are just kind of in a holding pattern, especially in some of the newer funds where they have to make capital calls on a per deal basis," said Chapter One's Morris Jr. "A lot of LPs right now are going through a tumultuous time in their own personal capital."

An opportunity to sniff out future winners

Even as uncertainty muddies the future of venture capital, VCs are keeping an eye out for so-called "antifragile" companies - companies that thrive in chaos - that will capitalize on the opportunities for innovation made apparent by the outbreak.

Investors are already predicting that remote-work and telehealth startups will come out of this downturn just fine, on the basis that customers have turned to them like never before.

Furthermore, this crisis may result in more opportunity: If valuations do indeed fall, VCs could have the chance to buy in to tomorrow's billion-dollar startups on the cheap, as they did during the Great Recession of 2008.

Even so, Jones warns, it's too soon for VCs to start getting greedy. He warns that among other things, there's always the risk that the novel coronavirus will continue to spread after the economy starts back up again. In that case, it's a possibility that governments around the world might have to institute a second round of lockdown orders.

So while there is opportunity for both VCs and startups to be found, he says that you "have to approach it very cautiously and understand that even after we're through the first lockdown, we may have to go through another one."

And get the latest coronavirus analysis and research from Business Insider Intelligence on how COVID-19 is impacting businesses.

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