TECH FINANCE
Already an uphill battle, fundraising for startups gets tougher in the pandemic
Fundraising for startups gets tougher during the pandemic.
Amanda Ducach, founder of a startup community for mothers, had just had the financial rug yanked out from under her. An investor who’d promised $100,000 reneged on that commitment after the stock market crashed in March as the U.S. shut down due to the novel coronavirus. SocialMama, the smartphone app on which her business is based, had launched a new feature connecting worried moms to medical, social and wellness experts. Suddenly, Ducach told the Chronicle in April, she was on the hunt for funding.
“Our runway went from months to, well, not months,” she said at the time.
But shortly after that story appeared, Ducach got an email from a woman who wanted her to come by and pick up a check to cover the money she’d been expecting. The woman had read the story, had been interested in putting her money toward a good cause, and chose SocialMama.
“She was a physician, and she really believed in the idea of our experts feature,” Ducach said. “And she thought it was unfair that we didn’t get the money we were expecting.”
As the COVID-19 pandemic grinds on, local tech startups such as SocialMama are finding the already arduous task of fundraising to be an even greater challenge. Investors are asking tougher questions of founders, and expecting them to be able to make a viable business both in strange times as well as in the next phase of “normal,” whenever that is and whatever it may look like.
There is indeed money to be found, investors and tech leaders said, but the cost is higher as valuations — depressed by stock market declines and the oil price crash — are lower.
“There is dry capital out there to deploy,” said Serafina Lalany, chief of staff at Houston Exponential, a nonprofit that supports Houston’s startup development organizations. “They are looking for founders who are capital-efficient, who can run lean.”
Global decline
The COVID-19 pandemic that sent markets tumbling in March and April as consumers hunkered down and businesses shuttered had a ripple effect on the sources startups rely on for funding around the world.
Startup Genome, a tech policy and advisory group, said in a study released in May that global venture capital funding
“There is dry capital out there to deploy. They are looking for founders who are capital efficient, who can run lean.” Serafina Lalany, Houston Exponential
dropped 20 percent since the crisis began in December 2019.
The study found that the drop wasn’t as severe in the United States, but there were still 15 percent fewer funding deals compared to the same months a year ago. And Startup Genome warned a lack of investment in new companies could bode ill for an overall recovery for the economy.
“Startups will be key to the economic recovery: they create most of the net new jobs in the economy, and are especially more relevant now as our society becomes increasingly digital,” the study’s authors wrote. “Yet, we are at a risk of a mass extinction event for tech startups. Governments need to act now to support these companies so that their digital innovation and economic recovery capabilities are not decimated. This is especially true for emerging ecosystems — those without the decades of experience and capital pool in places like Silicon Valley.”
That last sentence sounds a lot like Houston, where government officials and tech leaders are working to boost a robust startup ecosystem even as the area faces the additional challenge of a wounded energy industry after oil prices in April sank below zero. The price of crude has recovered somewhat, but layoffs are rampant and analysts warn more are expected.
Even though many investors are skittish, there’s still money out there to be had, as Houston Exponential’s Lalany said, but for a time it was hard to come by.
“March and the beginning of April were a wash,” said Blair Garrou, co-founder and managing director of the Mercury Fund, an early-stage venture capital operation based in Houston. “Investors were sizing up their portfolios and making sure their existing investments had a enough cash.”
Once investors had a better sense of where markets were heading, Garrou said, they began to be more interested in new investments.
“We made a new investment at the end of March, and we are actively looking at deals now that may happen in the June or July time frame,” he said.
The pullback hit some local startups particularly hard. Some thought the prize of funding within reach, only to have it snatched away.
At Houston Mechatronics, a startup that creates autonomous underwater robots, Chief Executive Nicolaus Radford was closing in on a Series C funding round “north of $40 million” when the market crashed. The company’s last funding round was $20 million in 2018.
“I knew it was just a matter of time before I got a call from our investor,” Radford recalled. Sure enough, that call came.
“He said, ‘Hey, listen, we are going to have to put this on hold indefinitely,’” Radford said. “It was … challenging. We had been engaged in a pretty lengthy process.”
He added that it has been “disappointing to see how many investors have backed off during this time.”
“In my opinion, this is when you push the pedal down,” Radford said.
A similar experience happened to Skylark Wireless, a Houston startup that began in 2012 at Rice University that is working on a technology to bring broadband internet access to rural communities. Clayton Shepherd, Skylark’s chief technical officer, said the company closed a seed funding round in December, and was getting ready to do a Series A round when the coronavirus lockdown hit.
Investors who had expressed interest suddenly weren’t interested
“All our investors told us no one is doing Series A rounds now,” Shepherd said.
Since then, Skylark has doubled down on applying for grants, he said.
‘Connections and conversations’
Some startups have been able to find funding, particularly when they offer a product that is useful during the pandemic and where relationships were forged before things went south.
Investors came through for Liongard, a Houston-based startup that develops software for managed service providers, or MSPs, which remotely handle others’ information technology systems. Joe Alapat, Liongard’s CEO and co-founder, said discussions with investors began late in 2019 and continued even as the pandemic’s grip began to tighten in the United States.
In mid-May, the company closed a $17 million Series B round. In almost three years, Liongard has raised $23 million from venture funds and individual investors.
“It’s connections and conversations,” Alapat said, saying the earliest discussions with potential and existing investors began well in advance. “By the end of 2019, we were having conversations in earnest rather than just talking about high-level touch points.”
It helps that Liongard’s product is extremely useful in a pandemic lockdown. It allows MSPs to work in their customers’ IT systems from anywhere, and Alapat said investors now are very interested in remote-access solutions. On top of that, MSPs are considered critical infrastructure and essential businesses, which also appealed to those who had cash to invest.
“The No. 1 question we were asked was how are our customers were impacted by the pandemic?” Alapat said. “Is our target market affected? And are our customers’ business models changed because of the pandemic?”
That was also the case with ThoughtTrace, a Houstonbased startup that develops software utilizing artificial intelligence to analyze complex legal and business documents.
Even though the company’s customers are primarily oil and gas companies, CEO Nick Vandivere said ThoughtTrace’s approach appealed to investors, who provided $10 million in a Series A funding round that closed in the first week of May.
“We have seen a good amount of growth even as oil prices have gone down,” Vandivere said, adding that his product cuts down on the amount of time companies have to spend going through exhaustive contracts. And like Liongard’s product, it is designed to be used remotely, which also appealed to investors.
ThoughtTrace also has been expanding its markets, providing versions of its products for other industries, including renewable energy, real estate, software and technology, utilities and telecommunications.
Michael Sklar, a former investor who now does consulting, said he thinks deals closing now are those that have been in the works for a while. And he has little faith that investors will want to do them remotely.
“If investors had met the founders prior to the lockdown, the odds of the deal going through are better,” Sklar said. “The idea that investors are going to make an investment in someone they have never met is unlikely. It’s very unlikely investments are going to be made over Zoom. I can’t imagine anyone writing a check to a Zoom face.”
Still, because travel and face-to-face meetings are risky due to the coronavirus, virtual meetings are the norm. And Houston Exponential’s Lalany said she has seen some enthusiasm on the part of investors for teleconferencing meetings with new startups.
To that end, Houston Exponential has launched Who’s Raising, a system for matching startups seeking funds with investors seeking opportunities. Founders fill out a form on Houston Exponential’s website, and staff members curate them and distribute the list to investors.
“We set this up three weeks ago, and were really astonished that people immediately started using it,” Lalany said. Ten new venture capital funds that had not looked at Houston startups have already expressed an interest in local companies.
So far, though, no deals have been signed, she said, but added that the lifecycle of an investment deal “is six months in a normal climate.”
“We have just started making introductions, it’s happening as we speak,” she said. “We’ll see where it goes from here.”