Funding is Slowing Down: What Can Start-ups Do?
The valuation of a company is a key indicator of? how well it is performing. However, market downturns obviously place downward pressure on the valuation of companies, even those with enormous potential. And with the decrease in valuation comes an associated negative impact on their fundraising capability.?
Tech start-ups that were booming at the peak of the pandemic are now facing a very different environment, with a marked slowdown. In a tough VC market coupled with the growing cost of debt, how does a start-up not only survive but also thrive??
The Deceleration
The rise of technology stocks has decelerated over the past few months. Deceleration does not mean a decline, just that the momentum of growth has slowed , compared with the dramatic upward momentum that we experienced over the last couple of years (largely driven by the excess liquidity caused by Governments printing money during the pandemic).?
This deceleration has been led by less-than-ideal performances of tech giants like Meta, Alphabet, and Amazon. For example, Meta lost $230 billion in valuation when it reported that its user base had declined in their first quarterly results of 2022. Further, Amazon reported that it had witnessed an operating loss for the first time since 2015. Similarly, even Alphabet reported that its revenues had suffered a decline in the last quarterly earnings.?
It's not just established technology companies that are bearing the brunt. Pandemic-winner Peloton (the start-up which sells connected indoor exercise equipment) lost 20% of its valuation over its report that demand for its products had fallen in the aftermath of the pandemic.?
Golden child, Klarna, closed their new round of funding which saw their valuation to $6.5 billion — about 1/7 of the $45.6 billion the company was valued at in June 2021.
In light of the market slowdown, institutional investors are also growing more cautious. For example, the SoftBank Group may cut down its start-up investment plans by around 50% for financial year 2023.?
A similar situation took place when the dot com bubble burst in 2001. However, the deceleration did not last forever and dot com companies beat pre-bear market valuations relatively quickly. Those who jeered as Amazon’s valuation dropped ended up changing their tune a few years later.? Is it possible that the current slowdown is also timebound and we may expect a reversal in trend?
The Lows?
Early stage/venture/growth funding comes with expectations. Investors invest to see start-ups grow into market leaders, to go public, or to provide a profitable exit through an acquisition. While VC expectations from start-ups were expectations of high risk/high reward, the scenario has become even tougher today as the reality of that risk plays out.?
Huge negative impacts on investor portfolios e.g. SoftBank and Tiger Global are expected to result in an unprecedented pressure on those who are seeking investment and the valuations they can achieve. So start-ups need to be pivoting, and pivoting fast, in light of the tighter funding options available, the longer investment cycles, and so on.?
I faced a similar scenario in 2008 with my own companies. We weathered the storm of the 2008 financial crisis by shutting down the early unprofitable ventures and merging operations of some of the other companies. In the end, having been forced to regroup allowed us to treble our revenues despite the crisis. This was thanks to some guidance from one of our board members @Mike Denoma. YCombinator’s valuable start-up advice is great advice for any founder on how to prep for a tough period ahead. So definitely make sure you check it out.
The Market
Over the last two decades, start-ups have become used to selling equity in order to raise funds. But, what happens when the capital markets are experiencing a downturn? Do founders scale back and forego their growth? Do they just accept a lower ownership share?
As outlined in the YCombinator email there are things you can do. An argument can be made that M&A can provide a good way out for start-ups that are struggling to scale their operations. A strategic M&A can help? purchase cash flow, gain access to other companies’ traffic and distribution channels, or gain a larger market share.??
One key problem is that many founders do not know how to approach M&A. The misconception is that M&A is only meant for large established players. However, M&A is a growth tool suitable for companies of all sizes.?
In the current market, where interest rates are expected to increase - VC models will change, and borrowing will become more expensive. Hence, it may be time for start-ups to consider M&A.?
The Highs??????
Source: Deloitte
In 2021 alone, the value of mergers and acquisitions hit $3.6 trillion, consisting of more than 35,000 deals. These transactions are expected to continue despite short-term fluctuations. Some of the start-ups that participated in M&As in 2021 include Clearlake – Quest Software ($5.4 billion) and Permira – Mimecast ($5.8 billion).?
There can be a variety of reasons for an acquisition. It can be done to gain access to clients and customers and also to expand into new markets and diversify offerings. Other reasons can include getting access to patents or licenses, purchasing new functionality, gaining access to specific geographic knowledge or data, and so on.?
Further, a lot of mergers in the technology sector today are being driven by the need to find the best talent e.g. Acqui-hires.
How to Sell Yourself
Obviously if you are selling your company you need to consider your valuation, what a buyer will pay.? It is not necessary for a start-up to have revenue streams or even customers for it to be sold for millions of dollars but it definitely makes it easier. In the current downturn, VCs are changing their model for funding start-ups. Few VCs are making funding deals in 2022 based on a 2021 valuation. And this continues up the value chain to the Private Equity (PE) firms.?
In this kind of scenario, when looking for buyers, a founder can focus on the broader market and target anyone who can utilize the potential synergies. The current trend of the technology sector is likely to be consolidation. This is primarily because startups will find it increasingly difficult to compete against funded competition.?
The ongoing volatility means that tech startups will be in a tough spot at raising or making previously raised money last as planned. The landscape is evolving. Tech companies are now being pushed to turn profitable sooner; they are left to either reduce expenses, consider alternative routes for growth, or to scale back their expansion plans, however that comes with its own challenges when fighting off others for market leadership in a new niche.
As for tech stocks, despite the liquidity tightening, there is no doubt that those with solid businesses will make a comeback. The way forward is to prepare oneself for a significant change in the market, to explore your options and to move early, very early.
Tech is here to stay so “batten down the hatches” and find a way to make sure you and your company are here to stay too, you and your company will be stronger for it.?
Good luck!
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