* Many startups are now navigating their first official recession in the United States after a historically strong market globally.
* Brian Patterson, a partner at Silicon Valley law firm Gunderson Dettmer, told Business Insider that he's been helping startups sort out their finances and extend existing funding since the coronavirus pandemic shut down the California Bay Area in March.
* Patterson said that the uncertainty rippling through public markets has materialized in private markets, which has led to lowered valuations and fewer founder-friendly terms on venture deals.
* Some deals that were in negotiations before March have fallen through or were entirely redrawn after the pandemic hit, Patterson said.
* The most secure way forward for any startup, according to Patterson, is to explore all merger and acquisition options over the next 6 to 12 months.
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The sky has officially fallen in Silicon Valley as the United States officially enters recession territory. The end of the economy's historic run, which insiders had been predicting on and off for years, is here.
Predicting the next bubble or economic calamity is one of the Bay Area's few seasonal pastimes, with founders and investors attempting to predict the future based on little more than valuations and tea leaves. But now that the recession is here, many startups are navigating the turbulent economic times for the first time.
Brian Patterson, a partner at Silicon Valley law firm Gunderson Dettmer, told Business Insider that he's been helping startups sort out their finances and extend existing funding since the coronavirus pandemic shut down the California Bay Area in March. The lingering shutdown and pending economic downturn has forced many startups to abandon expensive office leases in favor of remote work, and start looking to cut headcount as they scale back other costs.
"I've been working with those companies to find out how they've prepared, how they can stretch existing financing, or evaluate if they need to bring in new financing in the short term," Patterson said. "We're looking at how the business plans and runways change based on those factors, and they've all held board meetings in the aftermath of COVID where they considered if they need to totally revamp the models."
Frugality is of particular interest for venture-backed startups whose investors are evaluating how long the companies can last without outside injections of cash. Runway, or the amount of time a startup has before running out of money, is key to surviving long periods of economic uncertainty, Patterson said. Venture investors are not immune to the uncertainty currently riding through public markets, Patterson said. The delayed effects on private investing could cause even well-worn investors to hesitate before writing new checks.
"Many [investors] are saying they are open for business, but they have reassessed what it means to make a new investment in this environment," Patterson said. "It's all conducted over Zoom now, and many haven't actually closed on an investment via Zoom so it's a new dynamic."
That uncertainty is causing investors to step cautiously when they do decide to invest, Patterson said. This has put downward pressure on private company valuations, and has even led to renegotiations when the investors were unsure original deal terms could be sustainable in the current environment. The shift is a direct contrast to the founder-friendly terms that have prevailed in Silicon Valley over the last decade, Patterson said.
"I've definitely seen my handful of down rounds, but I don't feel like we are in the largest part of the curve on that yet," Patterson said. "The companies understand the money they raised in the last year or two, at the valuations they raised at, will be hard pressed to retain those values moving forward."
The down round is one of the ghosts of downturns past that many founders and investors dread. But Patterson said that many founders who have shorter runways and need funding soon will have to accept what is available at whatever terms investors are willing to give them. What founders may not realize, according to Patterson, is that venture investors are under their own kind of pressure to make sure the deal terms are in the interest of their larger investors, typically referred to as LPs. That could mean that even investors with the best reputations are forced to remove formerly founder-friendly terms from deals made under the current circumstances.
Investor terms that might have seemed overly demanding may now be rolled out again, such as provisions that guarantee an investor returns that are a multiple of the money they invested when the startup is sold or goes public.
"If you are competitive, you don't have multiples in your preference because that's a no-no," Patterson said of liquidation preferences that are specified by investors in such deals. "Including multiples is not founder-friendly at best and completely vulture-like at worst, and it's really demeaning your reputation as an investor. The fact that certain investors are bringing that into play now shows their LPs are demanding these VCs take a harder stance on the way these deals are structured and protect the interest of their own investors."
Patterson said he has seen at least one such deal fall apart during negotiations as the investor tried to renegotiate to include similar provisions. The deal was already in the works prior to March, he said, and so it felt like a relic from a previous time even just a month later.
Startups in similar situations with limited options have one promising path forward, he said. Pursuing a merger or acquisition could be the best way to shore up the company's finances without relying on outside venture investors, according to Patterson.
"All companies that are significantly impacted by COVID need to consider [mergers or acquisitions] if that's better than going it alone, given the inherent risks at a macro level and within the business itself," Patterson said. "It's being offensive, but in a smart way."
SEE ALSO: Steph Curry and Zoom CEO Eric Yuan just backed her college financing startup, and now this immigrant founder is tackling students' financial hardships brought on by COVID
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