19 Mar Venture Capital And Protein In Light of COVID-19
April 13, 2020
The COVID-19 crisis requires venture capital investors such as Lever VC to make thoughtful decisions on how to manage risk and seize opportunity in light of the current global quarantines and developing recession. A question we’ve been asked many times over recent weeks—by LPs, reporters, and fellow investors—is what implications this situation will have for the alternative protein sector, and how we think it will impact overall Fund performance. While our complete perspective would require more space than a blog post can contain, we thought it would be helpful to share key thoughts here.
First, let’s acknowledge the challenges posed. For portfolio companies that are currently working to expand sales to new restaurant and retail chains, we can expect such new listings to slow significantly over the next six months, given many western restaurant chains are shut down and retail category buyers are more focused on minimising stock-outs given the recent panic buying than on bringing in new products. Additionally, for portfolio companies raising a follow-on round in the next 12-18 months, many can expect to raise smaller amounts of capital at less favorable terms than they would have received otherwise (which is beneficial to our Fund if we choose to provide follow-on funding, although not so beneficial if we don’t). Additionally, given the onset of economic recession, all companies will have to more carefully control their burn rate, which means sales growth and research and development progress may be slower than it otherwise could have been.
Lastly, meat consumption tends to temporarily drop during recessions as consumers eat out less and are more price-conscious at the grocery store; during the 2008-2009 recession, meat sales dipped up to 5-10% for certain meat categories. Alternative protein products are often more expensive than conventional meat and dairy, although alternative protein consumers are also higher income and therefore less likely to significantly modify their food purchasing during a recession, so all in all, we might expect the alternative protein category growth to be 5-10% lower than otherwise expected. That would leave plant-based meat growing at 10-15% per year through the recession—less than the nearly 20% year over year growth we’ve seen in recent years, but still a healthy clip.
Those are some of the short-term challenges that will need to be navigated over the next 18-24 months. Long term though, we expect the COVID-19 crisis will ultimately benefit the Lever VC Fund and boost returns for several reasons—some specific to Lever VC’s focus on the alternative protein sector, and others more general to early stage venture capital.
Early-Stage VC During Recessions
The first reason is historical precedent. In analyzing the effect of previous recessions on VC returns, Pitchbook found that:
“The best-performing vintages tend to be those that invest at the nadir of a downturn and into the early stage of recovery, when entry multiples are lower, competition abates and portfolio companies benefit from macro tailwinds.”
While Lever VC has completed a handful of smaller early stage deals over the past nine months, nearly all of the capital that we will deploy over the lifetime of the Fund will be deployed during exactly that nadir through recovery period. Consider it fortunate timing, but Lever VC is well-positioned to benefit from the same macro tailwinds that have boosted the returns of similar VC funds launched at the start of previous recessions.
The 2008 financial crisis saw the emergence of some of the most highly valued VC-backed businesses, such as WhatsApp, Slack, GitHub, Airbnb, Stripe, Uber, Waymo and Pinterest, which rode the wave of the recovery to success. We expect to see a similar wave again, and are looking forward to helping our portfolio companies become this decade’s success stories.
One of the benefits to VC investors over the next two years will be the ability to extract lower valuations and more favorable deal terms. Pitchbook data shows that during the 2009-2010 recession, “early-stage valuations saw the greatest decline on a percentage basis over the same period, falling 27.3% before recovering in the latter half of 2011.”
The same process is already happening now, as Pitchbook notes in a separate memo:
“In deals being negotiated, we have already seen a downward shift in valuations, and deal terms have swung back in favor of investors following a prolonged movement toward founder-friendly terms.”
We at Lever VC have seen the same. In deals that we are actively negotiating, we have seen significant reductions in valuations from where they were pre-COVID. Given that a roughly 25% reduction in valuation translates to a roughly 33% jump in return multiples for companies that successfully exit (assuming an eventual economic recovery), it’s easy to see why VC funds investing during this period have higher-than-average returns.
History shows that, post-recession, valuation levels generally return toward pre-recession levels. Just as investing in public equities now would generate a significant return should markets return to pre-crash levels, similarly, the decrease in early-stage valuations means investments in early stage companies over the next two years will benefit from a sizable valuation boost purely as a result of the subsequent economic recovery. Assuming a 25% lower-than-normal valuation at the time of investment, portfolio returns will be juiced with up to a 33% additional gain in value post-recovery, on top of the general increase in value that comes from company growth. Therefore, thanks to investing during a recession and the lower valuations it offers, what would otherwise be a 50% growth in a portfolio company’s value becomes an 83% growth; a 100% growth in value becomes an 133% growth; and so on.
Over the past thirty years, such opportunities have come about roughly once a decade. The historical data suggests there has never been a better time since 2009 to be making early stage VC investments.
The second reason we expect the COVID-19 crisis to ultimately boost the Fund’s returns has to do with the sector we are focused on: alternative protein.
For one thing, food is not optional. We may see short-term drags on the impressive growth rate of the alternative protein sector, but such drags will indeed be temporary. While other sectors are being and will continue to be hit extremely hard by the crisis and recession, sales of protein and packaged foods have barely shifted. During the height of COVID-19 fears and the launch of quarantines around the U.S., customers stockpiling for the weeks ahead caused a jump in meat and packaged foods sales. But sales of plant-based meat soared dramatically higher still, with sales of fresh meat alternatives surging up to 450% and sales of prepared meat alternatives climbing 125% relative to the same week one year prior.
The demand for food, and the global increase in demand for protein, is not going away. But one question consumers and society are already examining more closely in light of the crisis is just where that protein is coming from.
The economic turmoil caused by COVID-19, as well as the disruptions caused by African swine flu, avian flu, ebola, and H1N1 over the past decade, have begun to expose just how devastating the risk of pandemics can be on the global economy. These outbreaks have had one crucial element in common: they were all incubated or hosted in animals consumed for food. Whether it was bushmeat in Africa (Ebola) or a seafood market in China (COVID-19), the risk of viruses jumping hosts is going to persist as a material financial risk for the foreseeable future. Our close relationship with animals in our economic system has created opportunities for deadly viruses to either mutate or share genetic material with already human-relevant viruses so that they can ultimately infect humans.
At Lever VC, we are investing in the world’s best new alternative protein companies—those producing healthy, sustainable protein without the need for live animals. Alternative protein companies are far less susceptible to the supply chain risks of animal agriculture (such as those caused by last year’s African swine flu), and alternative protein production has virtually none of the risks of incubating dangerous diseases that comes with conventional animal agriculture and wildlife protein consumption.
Alternative protein companies are already producing delicious meat and dairy products in controlled and sterile environments where animal protein can be grown using fermentation or cell cultivation, without the need for live animals and the diseases they can carry. Examples from our portfolio include Bond Pet Foods (producing chicken and other meat protein from fermentation), Avant (producing seafood and marine proteins from cell cultivation), TurtleTree Labs (producing milk from cell cultivation), and Mission Barns (producing pork meat and fat from cell cultivation). Other alternative protein companies are using plant protein to replicate the taste, texture, nutrition, and functionality of animal protein without any of the downsides. Examples from our portfolio include Better Meat Co (producing a plant-based protein blend that replaces pork, chicken or beef), The Good Spoon (producing gourmet eggless condiments), Marvelous Foods (producing plant-based yogurt), and Good Planet Foods (producing plant-based cheeses).
Not only are these cultivated and plant-based protein companies far less susceptible to future supply and demand shocks that we could face in a new age of pandemics, but they will also benefit from the tailwinds of a public increasingly concerned with the food safety, nutrition, and the provenance of their food. While all of this holds true in the United States and Europe, it will be particularly true in Asia, where only 57% of companies have some level of certification from the Global Food Safety Initiative and rapidly rising consumer demand will boost animal protein consumption by nearly 20% over the next 8 years, according to OECD-FAO data.
Alternative protein companies will continue to play an increasingly large role in creating a safe and secure global food system, filling the “demand gaps” generated by the combined increase in demand for protein and the increased consumer awareness of the personal and public health risks with the way conventional animal protein is produced today.
The economic recession brought on by COVID-19 undoubtedly requires us to make thoughtful decisions on how to manage risk and seize opportunity. Thanks to the stage and sector we are investing into, and our vintage year as a Fund, both historic precedent and on-the-ground conditions suggest Lever VC is well-positioned to not just weather this event but to benefit from it and secure outsized returns—all while helping build a safer and more modern global protein supply.