The last two weeks have been pivotal for so many tech startups (and most businesses across the board). Quick decisions are being made with incomplete information which could have huge impacts on future operations.
We’ve seen revenue flip from impressive growth to substantial declines. Share prices have fallen off a cliff. Those once realistic targets now look impossible to achieve.
As the UK slips and slides dangerously close to a recession, what impact is this having on the private markets? How are investors reacting to the new economic environment? What are the chances of being able to find new investment?
I put these questions to a number of investors to find out how they’re feeling. Here’s what I found out.
Venture capitalists (VCs) still have funds to deploy
VC firms raise their own funds which they subsequently invest into private companies. These funds are still there. That cash needs to be deployed, but that doesn’t mean it’ll be easy to access.
A number of investors that I spoke to said that they’re very much “open for business”, but that doesn’t mean it’s business as usual. These funds are being prioritised for portfolio companies (those that the investors have already put money into) to make sure they can be supported. Then the funds will be used for outside investments.
Angel investors are a different story
Angels are typically high net worth individuals. In order to invest, they need to shift assets around. This may be problematic if some of those funds have been invested in the stock market. The FTSE 100 index was hovering around 7,500 before the crash, and it’s now teetering around the 5,500 mark at the time of writing.
Lots of private wealth has been lost. We’re hearing, on more than one occasion, that investments coming from angels are being pulled from the table with little notice. With that in mind, don’t assume your investment raise is complete until the legal documents have been signed.
VCs are looking after their portfolio companies
Where companies have already received investment, it’s likely that the investors have been in touch to provide guidance of some sort. Startups are being asked to revise business plans and forecasts to reflect the new facts.
This generally comes down to two types of plan – the short-term plan and the longer-term plan. The short-term plan is a quick and dirty forecast that helps investors to prioritise who is in most need of support right now. The longer-term plan helps startups to process what’s going on and identify when, and how much, capital will be needed.
Whilst investors will be pushing startups to make the most of government facilities and to become more capital efficient, they also want their portfolio companies to know that the funds will be there as a last resort – after all, if the company fails then everyone loses.
Metrics and targets are being revised
In times like this, the worst-case scenario previously presented to investors starts to look like the best-case scenario. Investors are asking their portfolio companies to revise forecasts downwards to better reflect the current environment. As one investor quite rightly put it, “there’s no point reporting against previous forecasts that are now unreachable”.
There’s no point reporting against previous forecasts that are now unreachable
Seeking new investments
The general feeling here is that travel, retail and leisure-focused startups are off the cards for now. The time it will take for them to recover is usually off-putting for investors as it represents too high a risk.
When VC firms know the capital requirements of their existing portfolio companies, they can start to deploy the remaining funds to new investments.
As with most recessions, startups that are reliant on discretionary spending or target individuals with high disposable incomes are also low on the priority list.
On the flip side, startups with a focus on remote working and learning or biotech are higher up the list, especially if they’re thriving in the current climate. Also high on the list are companies with long recurring revenue cycles and products that are embedded into their customers (where the customer couldn’t easily operate without it). Contractual revenue is also a bonus.
We’re also hearing that deals are taking longer to go through, and not to breathe a sigh of relief until the legal documents are signed and the cash is in your bank account.
Valuation and investment terms
If you’re wondering how the fall in public markets will flow through to private markets, then this section will be of interest. Ultimately, it comes down to how valuations are calculated. They’re typically based on growth metrics and traction – the higher the growth, the higher the valuation. Growth targets are being cut across the board which means the valuations are being cut too.
These factors are driving down the valuation of companies meaning investors are able to take higher stakes for lower prices. This reflects the increased risk that they’re taking in the current environment, which reflects the same dynamics that can be seen in the public markets.
Growth targets are being cut across the board which means the valuations are being cut too
Down rounds (where a company raises at a valuation below their previous valuation) are now a very real possibility. These once were a huge red flag, but they’re now being seen with a little less caution.
Optimise for cash burn, not valuation
We’re hearing from multiple investors that extending the runway to at least January 2021 is important to see the company through this bumpy patch. This should give the funding markets time to recover and start the capital tap flowing again.
Revising forecasts should help provide clarity here. Startups should also be taking a critical look at their P&L to identify the following types of costs:
Nice to haves – costs that can be cut without any major impact.
Recurring but not committed costs – subscription payments fall into this category and it’s important to make sure these are controlled.
Committed costs – which costs are you obliged to make under any circumstances? Rent payments often fall here. Be careful not to sign up to new commitments right now.
Essential costs – which costs simply can’t be cut? Things like hosting costs and key employee salaries will sit here. Loan payments will also be relevant.
Scenario analysis now needs to take place – how far can you stretch the runway if all non-essential and uncommitted costs are cut? This will form the worst-case scenario. Don’t forget to adjust the other factors that may be influenced by cost cuts (i.e. cutting marketing costs in half will impact sales).
Once you have a worst-case scenario, you can identify capital requirements and build up from there into a more realistic scenario.
Make use of government schemes
VCs are pushing startups to make use of government schemes and not rely solely on their capital. We have published guidance on these schemes here.
Unfortunately, the current coronavirus Business Interruption Loan Scheme isn’t favourable for startups. This is because, pre-coronavirus, they did not have the kind of borrowing proposal that would get accepted.
Luckily, the coronavirus Job Retention Scheme, delay in VAT payments and time to pay helpline are giving startups a little bit of breathing space.
Be realistic and watch out for the “second-order effect”
When someone suffers a big loss in poker, it’s often seen that they will take bigger risks to try and reap back what they’ve lost. Bigger risks increase the chance of more losses, driving them further down into that trap.
Those that can effectively get out of this trap are the ones that accept the loss, readjust their mindset and start again.
As a founder, running a tech company is similar. As hard as it might be, you need to let go of those plans that you’d previously been trying to achieve. Take a moment to reset your current mindset and think of things as “how do we grow from here” rather than “how do we get back to there”.
Investors are looking for smart founders that have got this figured out and so aren’t masked by false optimism.
Most people will breath a sigh of relief after the first consequence, but it’s the subsequent consequence that hurts the most
Watch out for the “second-order effect”. This can have the ability to swipe an unsuspecting founder clean off their feet. This effect is built around the idea that every action has a consequence, and every consequence has a subsequent consequence.
Take a high-level example of the coronavirus for example. It spread across the globe and countries closed their borders (the action), which caused airlines to have to cancel flights (a consequence) which caused their share prices to drop (a subsequent consequence).
Most people will breathe a sigh of relief after the first consequence, but it’s the subsequent consequence that hurts the most.
Overall, the world has changed
To summarise, we’re clearly seeing that investors are being more cautious when deploying capital, but that’s not to say they’re completely closed for new business.
Startups need to use this time to look inwards and ensure they’re being optimised and streamlined as much as possible. Mindsets need to change and decisions need to be made using sub-optimal information.
At the end of the day, we don’t know exactly how long the coronavirus will ripple through society so uncertainty really is the only certainty.
With that said, you didn’t start a tech company because it was easy.
You did it because it was difficult.
You did it because you like to be challenged.
You did it because you want to make a difference.
We’ll get through this one way or another and, whatever happens, we’ll come out of the other end stronger and more experienced than before.
I’d like to thank all of the founders and investors that generously gave up their time to speak to me on this topic and share their valuable insights. It is hugely appreciated.
Article Credit: Robert Collings, UHY Hacker