CIBC Innovation Banking Podcast

Announcer:

Today, on the CIBC Innovation Banking Podcast:

Tony van Marken:

In many cases, the revenue is the same and the company continues to perform as it did previously. Now, obviously, this does not hold true in all areas. For example, if you're in B2C, in some cases, you've had a complete destruction of your revenue, if you're in the SMB market, you've had significant churn, but in the enterprise pure B2B software market, if you are providing software that is a must-have to the running of the enterprise, typically, you've seen those companies bounce back pretty quickly.

Announcer:

Here is Michael Hainsworth:

Michael Hainsworth:

COVID-19 has not hit the start-up community equally. Companies with exposure to the consumer are being hit harder than those exposed to the enterprise market, but First Ascent’s Tony van Marken points out even that is no guarantee of success, as coronavirus disrupts business models at all levels. While he is a fan of disruption, this isn't how he likes to see it come about.

Tony van Marken:

I'm not referring necessarily to disruption caused by COVID-19, obviously, that has serious health implications and loss of human life and economic consequences. I'm really talking about it from a technology perspective. I operate as a VC in the technology ecosystem and by definition, we work in a world where we're looking to invest in companies that are trying to disrupt the status quo utilizing technology, but saying that, COVID-19 has caused disruption in the world in which I operate. It's interesting to see how companies react and deal with that. I think COVID-19 obviously has created a different level of disruption in the tech ecosystem and I think what's interesting to see is how companies react to that and the playbook that they execute. I can take you through our view of how that's worked out, if you like.

Michael Hainsworth:

Absolutely, because I'd love to hear what kind of criteria you use as an investor in emerging tech companies to help you decide where to go from here because regardless as to the implications of COVID-19, we all must react and we're all being judged based upon how we react to this pandemic.

Tony van Marken:

Absolutely, Michael. I think what we've seen is that companies go through a process of recalibrating their operating budgets, they relocate this off to the home, they set up a work-from-home protocol, they put in the systems, security hardware infrastructure to do that. Most companies that are cloud-based can do that very easily and seamlessly. Companies that aren't, it's a lot harder.

Tony van Marken:

The second step then is to look at your operating budgets, headcount. How do you reduce discretionary expenditure? Very often obvious things you can do, like travel, conferences, et cetera, disappear, but then you have to be very discerning about how you manage all of the operating costs in the business because just raising headcount or reducing cost doesn't help if you are then negatively impacting customer delivery or product development or customer retention. You have to work through this very methodically. I think in our view, the one benefit of this disruption is it is forced management teams to look at their businesses very critically.

Tony van Marken:

It's interesting. In a pre-COVID-19 world, perhaps companies have enough cash or enough funding that they tend to be less focused on some of those elements, but now in this new world, everyone is focused on liquidity and runway and what does the forecast look going forward and focusing on, really, some fundamental business principles, which I think should have been followed in any event.

Michael Hainsworth:

Such as?

Tony van Marken:

Typically, managing the growth of a typical software company. What I've noticed across the ecosystem of companies have made some layoffs, but it's interesting that in many cases, the revenue is the same and the company continues to perform as it did previously. Now, obviously this does not hold true in all areas. For example, if you're in B2C, in some cases, you've had a complete destruction of your revenue, if you're in the SMB market, you've had significant churn, but in the enterprise pure B2B software market, if you are providing software that is a must-have to the running of the enterprise, typically, you've seen those companies bounce back pretty quickly.

Tony van Marken:

When we were in the middle of the blast radius during March, there was a drop-off in sales activity. Everyone was transitioning, it was tough to get meetings, there was a huge loss of activity that what we've seen in our portfolio now is that companies have come back, they've accepted this new normal, and I know that's an overused term, negotiating online, closing deals online. Particularly, when you're in large contract venues with companies in the, I'd say pre-COVID-19 world, at some point, you had a face-to-face meeting with a Fortune 500 customer to close a deal, but now that's been eliminated and both parties accept that that's not possible, and there's a new way of doing business. It's interesting to see how companies have completely adapted to that new playbook.

Michael Hainsworth:

Then draw on your own successes and failures as a chief executive officer. Help us understand what we can be doing as those who are running our own companies to succeed through this environment.

Tony van Marken:

Yeah, I think for every chief executive running a business, this is clearly a taste of leadership and I've had the pleasure to work with a lot of CEOs of our portfolio companies through this. I'd say by and large, they've all adapted really well. There are some very basic things I think everyone has to focus on: Clearly, taking care of your people and how you do that and how you communicate and getting out ahead of this pandemic.

Tony van Marken:

We had one case of one of the executives in our company getting COVID-19. What do you do when that happens? You realize you need to have a backup plan at every level in your organization in terms of, "Can someone else do your job if you're incapacitated for a certain period of time?" That person recovered. He's fine.

Tony van Marken:

I think that the messaging, the leadership, the empathy that you show with your teams, I think clearly, we've seen after two or three months, Michael, that people are Zoomed out. There's definitely a mental health challenge in companies as people are restricted and they're just working from home. You have to be incredibly sensitive to those things, but equally, you need to be still ambitious and driven and focused and resilient and persevere through this with your team, motivating them to build a great company, to adjust to this particular COVID-19 playbook.

Tony van Marken:

I think it's a question of not saying, "What is COVID-19 doing to us?" but, " What are the opportunities that come out of this? How can we build a stronger business? How can we use this moment in time to improve all the elements of our business?" because I believe you very quickly see what parts of your company are exposed in this type of environment. This gives you an opportunity to make some significant improvements in my view, come out stronger.

Tony van Marken:

I think chief executives have a key leadership role to play. I think what I've also noticed is the chief executives who've been through 2008 deal with us a lot better than the millennial CEO who was very young in 2008 and has really not seen a bear market at all on Wall Street, so these are new lessons learned for the younger CEOs, but I think they are valuable lessons learned in building a stronger ecosystem going forward.

Michael Hainsworth:

I saw an interesting tweet from a millennial: The time you're at a job interview and they ask you, "Do you have any questions?" you ask them how they responded to COVID-19 and that will help you make a decision as to whether or not you want to work for that company. I can imagine as a venture capital firm, you get to ask that exact same question, because you're looking to hear the exact same answer.

Tony van Marken:

That's a very good point, Michael. I hadn't thought about that, but this becomes, I guess, a leading interview question for employers and employees, but as a VC, for us, it would be sitting down with the management team and asking them, "What did you do in the first 30 days? What did you do in 90 days? What changes did you make to your business? How did you adapt? What went well? What didn't go so well? Did you build a stronger company as a result?" I think it's going to be a very interesting case study for all of us, whether you're on the investment side, how did we, as VCs, manage portfolios through COVID-19? How did individual companies adapt and thrive or not?

Tony van Marken:

I think one of the fundamental changes, Michael, I think for investors will be when you look at a company and if you have a view that pandemics could reoccur, is the target company susceptible to that type of event? Because if you're in a company that's in travel or leisure, for example, and you lost all your revenue, it could be pretty difficult raising money for those types of companies going forward.

Michael Hainsworth:

As they adapt, are you willing to even look at a company that hasn't adjusted its strategy or isn't seeking new opportunities to ensure their continued success in the reopen? 

Tony van Marken:

That's a great question. We look at the operational resilience of these companies. When we're looking at new investments, most of our criteria have not changed. What do I mean by operational resilience? Well, can the target company adapt up or down in terms of their operating model? For example, if the data indicates they should be cutting back, can they do that fairly effectively? Equally, if the data indicates that growth's possible and there's new bookings, opportunities, and there's customer demand, can you gear up equally as quickly?

Tony van Marken:

The other element of operational resilience that we look at is revenue. In the enterprise SAS world with recurring revenue, not all recurring revenue is created equal. For example, you could have a three-year recurring revenue contract with a Fortune 500 company of a hundred thousand dollars a year and it's a fixed amount, but if that amount is linked to seat count or employee growth or usage or transactions and your target customer has a revenue shortfall in their business and their business is experiencing a downturn, by definition, what you're able to bill is going down. That effectively creates a level of revenue churn in the business and reduces the resilience of the actual software company. We look very carefully at how software companies contract with their customers to get a better understanding of the resilience of their revenue streams.

Michael Hainsworth:

Any startup that can build its business during a global pandemic is clearly one that's going to be able to take off once we get on the other side of it.

Tony van Marken:

Absolutely. There are some great opportunities that have emerged during this pandemic that are specific to the pandemic. I'll give you an example. We have an investment in a companywhich is in telemedicine and it provides virtual healthcare. Their business absolutely exploded from the middle of March to today. They have hired over 400 healthcare professionals to join their team. 

Tony van Marken:

Michael, I'm not sure if you've needed to go to a healthcare professional during the last three months, but I had the misfortune of actually breaking my hand and had to get to a doctor in a hospital, but subsequently needed some physio and needed to see an orthopedic surgeon, all managed online. There are some brand new opportunities emerging because of this pandemic, but to your fundamental point, companies that can get through this and thrive are clearly providing something that's essential to the enterprise and that bodes well for their future.

Michael Hainsworth:

How do you trade off growth versus liquidity in this environment as an investor?

Tony van Marken:

That's a great question. What we've looked at very carefully in companies where we think the growth is going to be substantially lower, we've optimized for the cash runway of the company. In certain cases, we've made budget adjustments and reduce headcount with a view to looking at, let's say, 24 to 30 months of runway before we would need to refund those companies.

Tony van Marken:

I think you need to look very carefully, as a VC in my position, at each company: What are the criteria you would need to raise your next level of funding? What metrics do you need to achieve to get there and what current resources do you have to build the business and how do you optimize the amount of time you'd have to get there? We've had to look at it very carefully. Driving growth for growth's sake in this type of environment, I think, is not sensible.

Tony van Marken:

I think Q1, we really had one month of disruption. Q2 is going to be much more informative generally to the entire market about how companies are doing. Q3, depending on how things are opened up in the economy globally, we would expect some uptick in Q3 from Q2. You have to look at your data that's driving the business and be prepared to continue to make adjustments. We effectively run rolling 90-day budget review cycles with companies and expect to continue to do that as we get through this pandemic.

Michael Hainsworth:

That would give you an interesting indicator about where the industry is in its recovery on COVID-19. If you're doing rolling three-month budgets, basically, would that not give you a leading indicator about coming out on the other side?

Tony van Marken:

Yes and no. I mean, look, we're looking at our narrow niche in which we operate across our portfolio, but certainly, we get very interesting data. We've noticed, for example, Fortune 500 companies have made a pretty effective transition in terms of the acquisition and deployment of software. We look at the tempo of activity of sales teams in the enterprise: Do we have the same level of meetings and customers reaching out as we did pre-COVID-19 to today? We see that as a leading indicator of what's happening in our target markets of the different portfolio companies where we are invested. We get some early, I'd say, indicators of activity levels and the health of different companies as we go through this.

Tony van Marken:

Obviously, we are operating with technology companies in different areas, from investor relations to telemedicine to legal technology software, they're all quite different, but in every case, you get very interesting data about activity in that target market that does give you some idea of the health of the economy and how it's coming back, at least in those particular markets.

Michael Hainsworth:

What kind of levels do you need to see for you to feel confident that the worst would be behind us? 

Tony van Marken:

Yeah, I think the way we look at it is we're not necessarily waiting for some particular milestone. We continue to look very actively for investment opportunities in the market. We're looking for companies that provide a piece of technology that is essential to the running of an enterprise. That's the critical piece for us. If you can do that, and I guess it plays on the earlier point, whether you're in a pandemic-like situation today or not, those are the companies that will do well. There are opportunities right now for companies to optimize their businesses and come through this stronger.

Tony van Marken:

Equally, and this is quite Darwinian, companies with marginal business models before COVID-19 will find that they may not make it through this particular economic period. If you think about some of the great successes of ecosystems like Silicon Valley, they're not just successful because of the successful companies, they do well because of the failures, because the failures create lessons learned for people and the entrepreneurs and management teams who go through those go on to build other companies and learn from those successes and failures.

Tony van Marken:

It's almost sometimes helpful to go through this because the strong companies should persevere, show resilience, and get through this and become much stronger, very successful companies. Michael, I think we saw this post-2008. It was the same thing; certain companies didn't make it, but other companies 12 to 18 months later emerged as very strong players going forward.

Michael Hainsworth:

Tony, thank you so much for your time and insight. This has been great.

Tony van Marken:

Thanks, Michael. It's been a pleasure to be on your program. Thank you for your time.

Michael Hainsworth:

Tony van Marken is the managing partner at First Ascent Ventures. 

I'm Michael Hainsworth. Thank you for listening. Stay healthy, stay safe.

Announcer:

Subscribe to the CIBC Innovation Banking Podcast with Michael Hainsworth at cibc.com/innovationbanking.