We sent this letter to our investors this week and in our continued fund comms transparency, felt there may be some value in sharing an anonymized version publicly.
Dear Compound I investors,
As you all know by now, the impacts of COVID-19 are being felt globally both from a health and economic sense. Over the past few weeks we’ve seen markets decline sharply, as they attempt to process the true ripple effects and duration of a population standstill across various continents. While there is plenty of information floating around the internet to follow what is happening (we highly recommend Daniel Sinclair’s twitter account for deeper, real-time following of global COVID news), we feel it is important to update you on how we are handling this with our fund and portfolio companies. We’re sure you’ve gotten a lot of reading related to this, so we’ll be brief (relative to other things we send you :) ). If you have any other questions, thoughts, or concerns, please feel free to reach out and we’re happy to set up a video call.
Our Portfolio
High level metrics for our portfolio is as follows:
- The median runway within our portfolio is xx months.
- For our xx active positions where we have $1M+ invested into the companies, the average runway is ~xx months.
- For our x primary Series A+ companies, they are all well positioned with an average of ~xx months of runway.
As you know, we focus on companies that are building deep technological moats, with clear understandings of commercialization, and often aren’t predicated on heavy CAC or fanciful consumer spending trends. We think these companies will outperform in all markets, but especially in today’s current climate, we feel even stronger about our strategy and approach.
From a cash position, we feel our portfolio is in a relatively strong place as a seed fund. Our portfolio companies saw a large wave of follow-on investments over the past 18 months, and thus many have ample runway to recover from bumps in slower demand that may result in a base case or slightly negative scenarios. That said, we are starting to hear of 25–40% sales drop offs across many enterprise SaaS startups, and these effects on future fundraising can’t be taken for granted.
For the many companies in our portfolio that are building deep technology and solving problems that have never been solved before, they are raising next rounds off of technical milestones (A, B, C, and D are examples of this, among others), with commercialization expected at slightly later points than your average tech startup. Generally we feel good about these companies, however we are closely monitoring the market (which we’ll talk about) for follow-on financing and the barriers to Series A+ rounds.
For core companies that will rely on monetization moving forward for their next rounds, many of these have fared quite well even in the past few weeks. For example, (anonymized: talked through metrics of companies doing well right now and their current runways).
We expect companies like (anonymized: talk through companies that may struggle, and their current runways) could be impacted negatively due to slower sales cycles or freezes in procurement processes.
In addition, we feel good about having material reserves in our fund, while also still having capital allocated for ~8 new investments in 2020. As we mentioned in our annual letter, we feel that pacing of funds is important in order to have market timing diversity baked into a single fund, and this is a strong example of that, as we see prices likely come down.
Views on VC Markets & Our Investing
Our views on the VC markets can be summarized as follows:
- VCs are saying they are open for business as usual, however we’re confident that won’t bear out in the data, as metrics and the barrier to raise will likely get higher for these firms over the next few months. In fact, we believe if we look back at deals in Q2/Q3'20, we’ll see a slowdown (assuming a lag on announcements of at least 1 quarter, which is how data is largely calculated).
- As we mentioned above, we have ~8 new investments left to make out of Compound I that we believe will take through 2020 to deploy. We’re actively investing during this time period. That said, as we mentioned above, we believe companies that are built on immediate commercialization (specifically enterprise or non-staples consumer) could struggle for at least the next few months. Because of this, we are putting a greater emphasis on seed capital having a longer than normal runway (our average post-seed runway is ~18 months), as we don’t think that metrics needed for a Series A or beyond are going to materially fall. Thus, companies must be able to execute while pricing in their lack of customer development potentially through Summer 2020. That said, many companies we invest in spend the majority or large portion of their seed round in technical and product development. In those cases, we are gaining a deeper understanding of how R&D pace will be impacted by remote work at least through July 2020, and even perhaps through September 2020.
Advice to Founders
Our advice to founders can be summarized as follows:
- Slow down cash burn for at least the next 4 months, likely via a hiring freeze and perhaps even cuts. The fundraising markets, while still active, are definitely more scared and risk-off for likely the next few months at a minimum. Think about extending runway if you have ample capital right now and were planning a 2021 fundraise.
- If you had planned a Q2'20 or Q3'20 fundraise, let’s start talking about bridge financing now. Compound I is well positioned to help support our strongest companies, with ~$xxM in reserves left for follow-on, and we are actively looking at our stack rank of the portfolio and assessing confidence levels for both offensive and defensive bridge rounds in today’s economic climate, while staying close to understanding base case and worst case economic ripple effects due to COVID-19.
- Have strong plans in place to monitor both physical and mental health within your team. People are ultimately the atoms that make up your company. Don’t lose them, and always remember in these scary times that companies are just a collection of humans rallying around a shared goal.
As you can tell from above, our high level summary is that we expect a base case of slowdown and changed behavior likely through July 2020, with potential pivot points of extending that as we start to understand our impact via government-mandated social distancing, and with the biggest economic factors being a possible resurgence of COVID-19 in the Fall or sustained need for social distancing, as the unknown.
That said, we are deep believers in the technology industry and its financial standing, as well as the scale and moats that many companies have built or will build. Based on how the NASDAQ has performed versus other indices, public investors tend to agree.
We hope that you and your loved ones are staying safe in these sometimes scary and difficult times. Please don’t hesitate to reach out to either of us if you’d like to chat through any of this, or if you just crave some social interaction.
Thank you as always for your continued belief and support of our business.
Best,
David and Mike
