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Financing in isolation

VC activity will likely continue despite the COVID-19 outbreak

New Jersey venture capital activity has been healthy, but the COVID-19 pandemic could change that, at least temporarily, according to some experts. Besides spurring a pullback in new investments, the disease is driving venture capital and private equity communities to change the way they do business.

In 2019, Garden State-based VC funding rose to almost $2 billion, up from $714 million in 2018, while the volume of deals climbed to 58, up by seven, according to the latest PwC MoneyTree report. Nearly all of New Jersey’s deals are in “cities that are part of the New York Metro area (86 percent), and Philadelphia Metro area (5 percent),” according to PwC Technology Practice Assurance Partner David Silverman, who co-leads the firm’s Emerging Company Services National Practice. Companies that leverage artificial intelligence technologies or fintech business models are the hottest emerging areas nationally and in New Jersey, he added.

“Nationally we are seeing a trend of deal flow moving to new extremities of high-cost metros. Startups like hip, low-cost office space,” Silverman said. “As cities like Jersey City, Newark, and Princeton attract more startups, New Jersey as a state should attract more venture capital deals.”

 

Mario Casabona, founder and managing director, Casabona Ventures LLC.

Casabona

Some news isn’t so good. “In the near future, VC valuations will probably take a dent as a result of economic dislocations related to the coronavirus,” Casabona Ventures LLC Founder and Managing Director Mario Casabona said. “But portfolio company valuations appear to have been too high anyway.”

His $2 million micro-fund is currently spread out over 30 companies, including two that are based in New Jersey: Bright Cloud International, and Sunray Scientific. For the long term, he’s planning to maintain a focus on three areas: the internet of things, digital health and medical technology. “These represent the future because they all involve, to some degree, quantum math and applications, and material sciences.”

Casabona doesn’t think the COVID-19 pandemic will have a long-term effect on VC activity. “What we’re seeing is an immediate issue, which will likely be solved by a large pharmaceutical company with deep research and manufacturing resources,” he said. “So I’m staying the course regarding the kind of technology that I’m investing in.”

Stepping back

In the short term, he added, “the stock market plunge and the overall economic slowdown could put a hold in investor decisions. Right now, for example, I’m keeping my available cash on the sidelines instead of deploying it. I want to see how the market reacts in the meantime.”

The social distancing spurred by the COVID-19 threat is another issue. “It’s not exactly crippling,” he noted. “For a long time, our initial contacts with potential portfolio companies have been by phone calls, digitally through the computer, or we’ve done teleconferences.”

Still, he added, “Now we’re maximizing the use of technology when it comes to teleconferences, like using Zoom for Web-based conferencing. Nothing beats a face-to-face meeting, but that won’t kill an investment in a good company. We’re just exercising more caution in this uncertain atmosphere.”

Early- or seed-stage companies, which are typically funded by angels and smaller VC firms are particularly likely to feel a pinch, according to Gary Minkoff, an instructor of professional practice at the Rutgers Business School Department of Management & Global Business. “Based on the uncertainties created by the coronavirus, these investors are likely to feel — and it’s my understanding this is exactly what’s happening — that it’s time to move to the sidelines, or buy bonds, or even hard assets like gold.”

Investors will eventually return, he added, but they’re likely to be more selective.

Spreading the pain

Private equity, which usually focuses on more mature companies, is also on pause, according to published reports. “Investors are taking stock and evaluating risk,” Barron’s reported in a recent article. Added a New Jersey-based private equity managing partner, who spoke on condition of anonymity, “In-process deals are still closing, and some firms are jumping in now because of depressed valuations, but many are holding back.”

Venture capital or bank financing?

Venture capital can be attractive for startups and other growth-stage companies because it avoids the costs and restrictions of a traditional loan. But there’s another kind of cost, since business owners have to give up some equity in their company.

“Early stage companies often have a hard time getting bank financing,” said Aaron Price, chief executive officer of the New Jersey Tech Council. “Often, they don’t have much in the way of assets for collateral, so banks will want a personal guarantee from the owner. To avoid that, they may sell some equity to a VC provider.”

Also, most banks “aren’t really set up take the kind of risk a startup represents,” he noted. “Although bank financing may work at a later stage. One option at that point is venture debt,” where a bank or other lender receives warrants, or the right to purchase shares of the debtor’s stock at a certain price.

Even in the low-rate environment that’s been around for the last few years, venture funding retains some attractions, according to Gary Minkoff, an instructor of professional practice at the Rutgers Business School Department of Management & Global Business. “I think this is independent of interest rates because [VC] funders seek rates of return over long periods that compensate for the risk of a ‘guaranteed’ interest rate, and the lack of liquidity in the portfolio,” he said. “From the business owner’s perspective, there are several potential benefits to venture funding from a VC: the first is cash, but they also get access to the VC’s expertise and wisdom, industry knowledge and connections.”

The downside, he added,” is that you give up equity, and a venture capitalist understandably wants the most equity they can get for the lowest valuation possible. That means founders have their ownership stakes diluted – sometimes by a lot.”

In general, investors get “a little more timid in uncertain economic times, like we are in right now,” cautioned Thomas Wisniewski, managing partner at Newark Venture Partners. “Some may react negatively, slowing or stopping investment deals, and they may pull back into a wait-and-see mode. The good news for startups though, is that in 2019, $46 billion was raised by U.S. based venture capital firms across 259 new funds, the second largest behind the $58 billion raised in 2018. This means that there is a significant amount of ‘dry powder’ in the market for investing in startups, which was not necessarily the case in the 2001 and 2008 downturns.”

Wisniewski said he thinks VCs will continue to be active, especially since valuations may fall a bit in order to get deals signed. At Newark Venture Partners, “We are long-term investors, and will consider the current climate before signing a check but we are still signing checks. We are actually currently sourcing for our eighth NVP Labs cohort,” which offers coaching, financial and other assistance to promising startups.

A red flag

Until now, VC had been jumping, noted Jonathan Hakakian, a partner in Soundboard Venture Fund.

“About 10 years ago, it was difficult to get 30 people together for a VC conference,” he recalled. “Now it’s usually standing-room only.”

But the pandemic slowed that down, at least temporarily. “Demo days and pitch days may be delayed, but they won’t be shut down,” said Hakakian, referring to get-togethers where startups pitch their business to investors. “The long-term strategy of investors is still on track, but there could be a pause while we switch over to different ways of contacting each other.” His plans include a teleconference where six companies will present their ideas.

Soundboard has about $8 million invested across 50 early stage, tech-enabled companies. It’s been active since 2012 and is now fundraising for the second round. “We hope to raise a significant amount, but the process may take a bit longer given the coronavirus situation,” Hakakian said. “The world is being shaken up right now and people are just focusing on their health.”

New models

The COVID-19 crisis may slow down some venture capital deals, but crowdfunding — or raising small amounts of money from a large number of people, mostly through the internet — has jumped, according to Karen Cahn. She’s the founder and CEO of IFundWomen, a Montclair-based platform for women-led startups and small businesses that provides access to cash, coaching and other services.

An entrepreneur can generally go after “rewards crowdfunding,” where the business owner will exchange a product or service, typically at a discount, in exchange for funds; or “equity crowdfunding,” where funders receive shares of a company for their money.

Karen Cahn, founder and chief executive officer of iFundWomen; inaugural entrepreneur-in-residence, Montclair State University.

Cahn

“Post-coronavirus, we’ve seen a two-times jump in the number of women coming to us from startups,” she said. “It’s exacerbating an existing drawback to venture capital: other than certain tech categories, very few small businesses were able to get venture funding. So more everyday brick-and-mortar and other entrepreneurs are turning to crowdfunding.”

Besides the funding platform, Cahn said IFundWomen also offers advice and access to grant opportunities. Her organization also offers networks, like IFundWomen of Color.

One business, a Brooklyn-based minority private membership and workspace organization called Ethels Club, initially crowdfunded with IFundWomen, raising a reported $25,000. It subsequently raised $1 million from a VC, said Cahn. “Woman-owned businesses will be the hardest hit in this crisis,” she added. “Crowdfunding platforms like ours can help them get through it.”

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