In fear of not banging the same old drum let’s not start with the obvious – markets are down, companies are under intense financial strain, we haven’t seen friends or extended family for weeks, the health and wellbeing of loved ones is at risk, and no one has a clear grasp of when this will end.
Instead lets break down some of the specifics and unpick the immediate impact for tech start-ups and their backers, and where we go from here as the world tries to predict when we will return to growth – with wildly differing views from 3 months to 5+ years – we’re far from a consensus.
The impact for start ups
The most immediate impact is a slowdown in revenues, to what degree is more dependent on the market they serve and ultimately how robust their customers are themselves. Are the services and products they deliver still in high demand or like in the travel and hospitality sectors has it dried up almost completely with bookings for some down by 90%. Airbnb have seen a 40% drop since the outbreak and are likely to now delay their long-awaited IPO which was previously planned for this year.
Depending how quickly revenues slow down, and how well funded the start-ups are will present different challenges. For any with a runway of less than 12 months there is a significant risk of collapse. Many VCs are advising their portfolio companies on drastic cost cutting measures and headcount reductions, and almost certainly hiring freezes (unless you’re Zoom, or in the remote working arena). Executing an effective lifeboat plan is critical, and if it hasn’t already been implemented, start-ups should get to the task right away.
Beyond preserving existing cash and funding, many will also be looking to raise bridge rounds or even bring forward the next funding milestone – albeit likely at a lower valuation than anticipated. Obviously, survival is the first step to success, and so this will test many founders resolve in needing to stomach a significant haircut and likely closer scrutiny of the use of funds. The public markets have dropped upward of 30%, but private markets could arguably drop further as there is a sense of the unknown for how bad this will get – firms making investments during the coming weeks are quoting valuation ‘re-calibration’ of 40-50%, and some even more. Better to stay alive than to let pride stall cash needs though, right?
In the UK, the Government have taken steps to support small businesses but so far this hasn’t filtered through to loss making start-ups – which in tech is clearly commonplace. There have been calls from the industry to change this and citing France as an example which has issued 4 billion Euro fund to support cash strapped start-ups. The British Business Bank has called for a runway fund to support the same. If you’re making a profit, then there are a number of loans and grants on offer and more likely to be added over the next 1-2 weeks.
Just as start-ups themselves are facing challenges, the firms who are backing them are also under pressure. There has been a shift in investment thesis, and certainly a more cautious tone to the types of companies and business models which are lower risk and seen as more robust as we enter what some are calling a deep and prolonged recession. Life isn’t easy, and there are many differing views.
An interesting report created by Chausson Finance gauges the general sentiment among the industry with 68 VCs taking part and presents a general view for how the industry gets back on track. Some of the interesting stats include; a seismic shift from focusing on growth, to cash and specifically to get into shape for an 18 month runway, with 25% of VCs blocking new deal flow so they can focus entirely on their existing portfolio to help restructure and re-forecast in addition to potential cash needs. Of the VCs surveyed, 77% believe CV-19 will have a dramatic impact on their investment strategy for another 2 months but do believe beyond this there is light at the end of the tunnel, with only 22% predicting it will last longer.
Seed funding is predicted to drop by 20% over Q1 with official figures yet to be released – but early indications are predictably pessimistic. Beauhurst has reported just 344 equity rounds, which is the lowest figure since Q3 2014 and a stark 32% drop from Q4 last year. Whilst there is a drop in the volume of deals being closed, this marks an opportunity for the investors who haven’t lost their resolve and remain committed to backing strong start-ups. Another survey which is open source and now has over 320 VCs participating provides a generally positive view of the state of play, and most still actively pursuing new deals, with a number closing transactions in March.
Private Equity’s horizon
In speaking with a number of PE firms over the past 2 weeks, the sentiment on the transaction side largely mirrors that of venture. There is an appetite for finding great companies, and of course many have a large war chest of funds to deploy. Valuation multiples seem relatively unscathed depending on the sector and business model, but this may start to change as more time passes and earnings reports filed, Q2 may present a different outlook, however. There is however likely to be a slow down on the sell side and so first to the table PE firms are still chasing deal flow, but when it comes to selling the asset on there will predictably be a slowdown. Many firms will look to hold assets and sell when the market pick up resumes and so there could be a bottleneck leading to a slowdown in M&A short-medium term.
With challenge comes opportunity
For those start-ups and investors who continue to innovate, and don’t wait for the market to save them – there are many opportunities to be leveraged. Challenges like the one the world faces today will push business to become better, stronger, more resilient, more efficient, and more agile than ever before – and this can only be a good thing. There will certainly be a shift in the power sectors and companies within them, but tech as a whole is extremely well positioned to come out stronger – be it health and biotech, enterprise collaboration, remote working, food delivery, home fitness, or fintech – there are new winners waiting in the wings.