This article was published in the Fall 2020 issue
by Greg Warnock, Co-Founder and Managing Director, Mercato Partners
Success for venture-backed companies depends on a myriad of factors, large and small. Some are internal, others external. In that context, COVID is one more very macro variable affecting successful investment outcomes over a finite time span. Thus, one common error entrepreneurs might make is either excessive optimism or pessimism based on mistaking the impact of COVID on their particular business. Whether the founders see this as a crisis or an opportunity, there most certainly is an impact--that is clear--but the definition, the direction, and the duration are varied and unique for each business.
Specific COVID response strategies are as diverse as the companies that comprise the economy, but they can be split into two categories: offensive and defensive. Defensive strategies include cost-cutting measures or accessing government relief dollars. Offensive strategies include the pursuit of incremental revenue from COVID-driven market dislocations or increased marketing to highlight efficiencies or cost savings. We have seen both play out inside our portfolios and continue to see robust innovation in our pipeline.
For that reason, Mercato is optimistic about our investment prospects. Our business is finding and funding disruptors poised to breakout. These emerging businesses have characteristics that favor market upheaval and uncertainty. For example, in turbulent markets, customers reevaluate expenses and may be less loyal to current relationships. They may question product pricing and feature mix. They’re likely under extraordinary pressure to improve productivity, making them receptive to daring innovation. It’s harder for them to say ‘no’ to a new way of doing things because they may be reevaluating their decision processes. With more flexibility and less loyalty, incumbency is weaker, favoring the challenger.
Because of the erosion of market habits and the weakening of incumbency power, all of the funds at Mercato see COVID as a destabilizing force favoring the funding of market challengers. In some cases, a decade of healthy economics has lulled market leaders into complacency and stagnation. COVID may further erode their competitiveness and cash position, favoring challengers. Many incumbents are vulnerable due to high burn rates and infrastructure expenses built to support the pre-crisis environment. In the COVID-affected market, agility, innovation, and a strong cash position will win every time.
Mercato invests in rapidly-expanding challengers possessing a growth mindset, an innovation culture, and a range of strategic paths to success. At the same time, market upheavals like COVID often drive a “flight to quality” for investors. This leads to a concentration of investment interest in a smaller number of clear market winners, inflating prices. Mercato’s focus is in underserved and over-looked markets where there is less such artificial over-concentration. As a result, our pipeline of opportunities is more balanced, less contested, and un-banked. We continue to find many of these companies in the wild, but in today’s environment, they have fewer active sources of capital and more pressured balance sheets. This is where we can help match investment to ideas. In light of the current conditions, in addition to our historical filtering criteria, we have expanded consideration of various company characteristics related to COVID strategic responses.
We see a large number of qualified opportunities within the fields of secondary and tertiary geographies for our areas of focus which range from cybersecurity to SaaS to consumer, and food and beverage for our Savory Fund. With active portfolio companies in locations ranging from Salt Lake City, Boise, and Denver in the Intermountain West, to St. Louis and Chicago, to Southern California, our team has quickly adapted from a mix of in-person and remote sourcing activities to all-virtual. Our core principles in the areas of sourcing, investing, collaborating and helping the harvest have not changed though.
During the pandemic, Salt Lake-based Galileo Financial Technologies exited with a purchase by SoFi for $1.2B in April, while another Utah-based Mercato portfolio company, Central Logic, was acquired by Rubicon Technology Partners in June. Kalderos, a Chicago firm revolutionizing prescription drug discount management raised its B-round in May with Mercato and Bain Capital Ventures executing the deal entirely remotely (including the celebration dinner).
For us it is certainly not “business as usual”. Instead, we continue to execute our usual business through unusual means. The pandemic has changed how we do business. It has not changed the “why” or, in Mercato’s case, the “where”. Good businesses need capital. Investors seek returns. Innovation demands an outlet. COVID has impacted commerce but not creativity. Our legacy – seeking rare opportunities in underserved and overlooked markets and applying stage-specific guidance – is adapted to weather this crisis and continues to serve well our entrepreneurs, our investors, and our communities.
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