Artturi Tarjanne, co-founder of Finland’s oldest venture capital fund, Nexit Ventures, experienced the financial crises in 2000 and 2008 as an investor. In 2000, before the burst of the dot-com bubble, venture capital funding was plentiful. But in 2001, after the market crash, funding for start-ups dried up almost completely, says Tarjanne.
“VC funds ran out of capital quickly. International VC funds exited the Finnish market, which meant that growth companies had to rely entirely on domestic VC investments. At the same time, portfolio companies’ need for financing increased wildly, as they lost their markets,” he says.
Tarjanne recently joined other experts on a webinar Nordea held for a start-up audience on April 14th about the outlook for venture capital funding during the COVID-19 pandemic. See the full webinar here (in Finnish). While the circumstances are different this time around, it’s helpful to look to past financial crises for lessons when it comes to venture funding.
What have we learned from previous financial crises?
After the dot-com bubble burst, the recession in the early 2000s put a stop to M&A activity, and money was no longer being ploughed back into new investments, says Tarjanne. At the same time, corporate venture capital programmes were shut down as venture funding was one of the first things large corporations decided to cut back on.
The limited partners (LPs) behind the VC funds, whose assets were tied up in equities, properties and other investments, didn’t want to sell their investments and realise heavy losses in order to fulfill their obligations to the VC funds. Some LPs simply ran out of money. Some funds shrank in size under pressure from the LPs, and new VC funds were no longer established.
As a result, almost all VC funds disappeared from Finland over the next few years as investors shifted focus to their home markets. With fewer investments and a downright lack of money, companies’ valuations fell by as much as 50%. At the same time, venture capital investors imposed stricter financing terms, not least when companies started to run low on cash.
Will this time be different?
At this point, it’s difficult to know how long the economic fallout from the corona pandemic will last. In previous crises, the amount of venture capital funding has followed the Nasdaq index with a slight delay. As the Nasdaq rebounds, more money will likely be poured into start-up funding, too.
In Tarjanne’s view, the current situation doesn’t seem quite as gloomy as the previous crises. He says it looks like public funding will be used to remedy the situation more quickly and actively than during the economic crisis in 2000, for example.
When the market is doing well, venture capital investors usually see growth potential as the most important criterion for investment. In a tight market situation, profitability becomes more critical when evaluating potential investments. If the market disruption persists, investors don’t want to pour money into businesses that are constantly making losses. This is why a realistic assessment of the company’s future financing needs is a key criterion, i.e. how much money is needed to reach a positive cash flow, according to Tarjanne.
From peak year to emergency
The past few years have been fantastic for venture capital investors, according to Sami Lampinen, chair of the Finnish Venture Capital Association (FVCA) and Founder of the Nordic technology fund Inventure. Up until Q1 in 2020, we saw some great funding rounds. However, due to the emergency caused by the coronavirus, investors have increasingly turned their attention from the early-year rounds to their existing investments.
“Investors had to figure out where their portfolios stood after the outbreak – and whether they needed to go full throttle or make some tough decisions. It’s also important to calculate the capital runway and assess the outlook for the next 6 or 12 months,” Lampinen says.
It appears that VC funds are now earmarking more money for their portfolio companies’ further funding rounds. We’ll also see bridge funding rounds designed for short-term funding to ensure viable companies have the funds they need, he adds.
“There will also be new funding rounds, but they will probably be split into slightly smaller increments. This will give the team time to prove they can handle the current market situation before further investments,” he says.
Under Lampinen’s leadership, Inventure has grown to a team of 10 that works actively with entrepreneurs in both Finland and across the Nordics. In 2020 and 2021, the fund is planning to make a dozen new investments of moderate size. As an experienced investor, what advice does Lampinen have for start-ups seeking funding?
“I’d like to highlight the importance of a global network. International investments play a crucial role especially when a business is trying to get back on a growth track,” Lampinen stresses.
5 tips for start-ups during the pandemic, from Reima Linnanvirta:
- Cash is king. Postpone all non-essential investments and take advantage of payment holidays and cheap working capital finance.
- Keep your existing investors close, as they are most likely to participate in the next funding round, too. Their active involvement will also encourage new investors.
- Ensure open communication. Announce both good and bad news. Also remember to communicate if there is no news.
- Update your business and financing plans. Any plans drawn up before the pandemic are no longer relevant. Build a strong foundation and make a more tangible plan.
- Great companies will always find funding. The investment horizon for a business angel is 7-10 years. Make sure that your business adjusts to the coronavirus situation and is able to ensure long-term performance. Keep in mind that the corona pandemic also creates new opportunities.
Where have all the angels gone?
According to Reima Linnanvirta, angel investor and Chairperson of the Finnish Business Angels Network (FiBAN), the past few years have also seen record-breaking investments from business angels. Over the past two years alone, FiBAN members have invested in more than 400 new businesses in Finland each year, he says. This also means there will be a record number of companies looking for further financing in the future. As venture capital investors will now focus more on their portfolio companies and invest less in new businesses, business angels will do the same.
“Business angels can now play a bigger role in further financing. Most angels are motivated by the opportunity to give back. They have typically had a long career as an entrepreneur and are thus looking at investing from a more personal and value-driven perspective. Angels have by no means disappeared off the face of the earth because of the crisis,” Linnanvirta assures.
He underlines that it’s essential for start-ups to see a way out of the coronavirus crisis. They’ve had it easy for the past 12 years. Now it’s time to listen to their investors, many of whom, unlike the founders, have also experienced other crises.
5 things an entrepreneur now needs for a financing negotiation, according to Vesa Riihimäki:
- Latest financial statements and a recent assessment of the impact of coronavirus on the company’s financial standing
- Total funding raised, including loans from other financial institutions and grant funding
- Analysis of the impact of coronavirus on the business
- Information on the current owners’ ability to make further investments
- Information on other measures available: what has already been done to adjust to the pandemic and what more can be done if the crisis continues? This includes rent, salaries and other recurring costs.
Nordea’s Startup & Growth continues to support existing and new customers
Nordea’s Startup & Growth unit hasn’t turned off the funding tap. Instead, we’re making arrangements for our existing customers to help them get through the crisis and providing additional financing to both existing and new customers.
“We continue to welcome new early-stage businesses as well as start-up and growth companies that have financing from other banks with open arms,” says Vesa Riihimäki, Head of Startup & Growth Finland at Nordea.
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