How one European VC firm is reacting to the economic crisis

Public markets around the world have been tanking for the past few weeks, and many companies simply can’t operate during a lockdown. Sheltering in place has had some terrible economic consequences, with a record number of Americans getting laid off, including many startup employees.

But what is happening in Europe? You might also be wondering whether European tech startups have to lay off a significant chunk of their workforce and whether financial capital has become scarce.

That’s why I interviewed Jean de La Rochebrochard, a partner for Kima Ventures, backed by French telco and media entrepreneur Xavier Niel. They focus on seed and Series A investments and invest in dozens of startups each year. He oversees hundreds of startup investments at any given time, which means he has his finger on the pulse of the tech ecosystem in France and across Europe.

The interview was translated from French and edited for clarity and brevity.

TechCrunch: At Kima Ventures, have you seen any change when it comes to investment pace?

Jean de La Rochebrochard: There has been a big change at the deal-flow level. But we already committed to some deals before the lockdown. We’re currently closing all the deals that we were looking at. Over the past 15 days, we’ve closed 15 deals, I think.

So it might slow down in the next 15 or 30 days…

Yes, it’s going to slow down, that’s for sure. But we’ll only know for sure in a month when we’re done with our backlog.

How do you explain that your deal flow has slowed down? Do entrepreneurs censor themselves?

That’s exactly what’s happening. Our attention has shifted from inbound deal flow to portfolio management. Before, we would spend a quarter to a third of our time on our portfolio, and two-thirds to three-quarters on deal flow. Now, it’s the exact opposite. We’re going to allocate a quarter to a third on deal flow and the rest on our portfolio.

The cognitive bandwidth of investors on deal flow has shrunk. Entrepreneurs realize that. Instead of getting turned down abruptly, entrepreneurs who can wait a few weeks… They’re smart.

Entrepreneurs who contact me today, I see that they don’t understand the current situation. They seriously lack self-awareness.

In your portfolio specifically, do you face unprecedented situations?

We have decided to sort our startups in four quartiles. In the top two quartiles, companies are doing fairly well. In the last two quartiles, they’re doing so-so.

In the top quartile, we have companies that were doing well before the crisis and that have cash reserves. They’re going to manage the situation in the most responsible way possible to get through winter. I’m not telling you that we’re not worried for them, but we just check that they’re addressing the situation.

In the second quartile, you can find companies that have a solid pre-crisis foundation. This foundation is still true but they were at the end of a financial cycle. They don’t have enough cash to get through this year. How are they going to raise money? That’s the issue. We’re trying to see if they can raise a bridge round in order to have enough cash so that they can start fundraising during the summer or fall 2021.

For example, we have a portfolio company that was about to raise a €30 million round. The lead investor dropped them two days before closing the round. That company managed to raise one-third less at a valuation one-third lower. The deal was done really quickly because it has a strong foundation, the company is doing well. But that’s the market right now. Companies are going to raise one-third less or even 50% less compared to what they were supposed to raise before COVID-19 — and the valuation is cut in half.

You’d say that the difference between the first and second quartile is the amount of cash in the bank account?

Absolutely, that’s the only difference.

In the third quartile, you’ll find companies that don’t have an insane growth rate. Some parts of their business model are still shaky and they don’t have a lot of cash. Those companies seriously have to trim down their expenses — quite drastically. Investors won’t necessarily spend a lot of time looking at them to inject cash in those companies. Those companies will suffer.

And then companies in the fourth quartile are companies that are going to shut down.

Companies in the fourth quartile would have gone bankrupt anyway?

Probably. Those entrepreneurs haven’t found a product-market fit or didn’t grow as fast as expected. Or they didn’t execute as well as expected.

When you talk about trimming down for the third quartile, what does it mean?

Fifty percent — 50% staff reduction, even though those companies were only burning hundreds of thousands per month when they were investing hard. Those companies are going to scale down to burning €50,000 to €100,000 per month. They’re going to stay afloat as long as possible.

So you predict layoffs at French startups…

Yes, that’s for sure. But I know plenty of companies that are doing well but couldn’t recruit talent. There was a talent shortage and there’s going to be talent on the market, so that’s good. When you lay off 100 people, you’re not going to see 100 people looking for a job — half or two-thirds are going to be hired quite quickly.

By other tech startups or tech giants?

Both.

Will some industries be affected mote than others when it comes to cash burn and liquidity?

It’s a good question — I don’t know. Just look at Lime right now [Lime’s valuation is reportedly down 80%]. Business models like Lime, Deliveroo and Uber are only focused on pure growth. When there’s a crisis, unit economics don’t work anymore.

But marketplaces could more easily scale back…

Maybe. This crisis could be an opportunity for some companies that had raised a lot of money. They could use this opportunity to go back to their core business because they were doing crazy stuff.

What are you thinking about, at the marketing level, because of the size of the teams?

At the global expansion level. I think those companies are going to scale back to their core geographies and core market.

What do you think of France’s support plan for startups?

Some people criticize it, but I think France’s public investment bank is supposed to be a supermarket. They’re not supposed to tell you: “You get in, you don’t.” As long as you fit the bill, you get in every time. And that’s really good for companies that can take advantage of those aids.

All our companies are going to take advantage of the plan. The issue with the European ecosystem is that it’s still booming and it hasn’t reached maturity. We don’t have very, very big companies so it’s much easier to die than to survive in that ecosystem. If you let companies shut down too quickly before they become big companies, it becomes “Resident Evil” and it’s ugly.

If we look at VC firms, do you think some firms are going to report terrible returns and won’t be able to raise another fund?

Firms that were in the process of raising a new fund are going to suffer. As for others, funds that still have enough cash for the next two or three years, they’re going to slow down and are going to wait so that valuations go up again because unrealized gains have taken a serious hit.

Ten percent of VC funds generate 90% of returns. The power law is true for entrepreneurs — but it’s true for VCs too. The only thing that I know for sure is that everybody has a shot when market conditions are good. When things get more difficult, only those who know how to adapt have a chance at succeeding. It’s true for entrepreneurs and VCs.

How long do you think the crisis is going to last before things go back to normal?

I think recovery starts in September, things go back to normal around the holidays. That is, if we manage to find a solution to the health crisis. I’m quite optimistic, but I think growth, valuation and round sizes will go up again in Q3 or Q4 2021.

The U.S. is getting crushed and that would suck if they can bounce back more quickly than [Europe]. We saw it with the last crisis — the U.S. got crushed and bounced back immediately.

When you say the U.S. is getting crushed, are you talking about layoffs?

Yes, it’s extremely violent. Europeans put a lot of money on their savings accounts while Americans have a lot of debt. I’m concerned that the health crisis is going to trigger a bigger crisis at this level. I hope it’s not going to get out of control because we need Americans.