Technology investors remain bullish despite market slump
Venture capital firms are putting on a brave face as the crumbling market makes life more perilous for tech startups, writes Eric Johansson.
Tech investors remain optimistic about the future despite market meltdowns. Some even suggest it could benefit the industry in the long run. However, they urge startups to prepare for leaner times.
“There is an entire generation of founders that have only experienced a bull market, where money is cheap and terms are easy,” says Stefan Tirtey, managing partner at venture capital (VC) firm CommerzVentures. “Where you used to be able to raise money with inspiration and promises, today the fundamentals of cash flow, capital efficiency and unit economics are king.”
Fast-growth ventures should heed that warning. The industry hasn’t had a great year so far. Stocks of publicly traded technology companies have plummeted. Consequently, tech investors have taken a battering. Investment giant Tiger Global, for instance, has lost billions of dollars this year.
Tech investors can blame the current market uncertainties on several factors. One is the cost of living crisis that built up following the pandemic. With the Covid-19 crisis somewhat coming to an end, governments must now foot the bill for their crisis packages.
The war in Ukraine has exacerbated the situation, with the Russian invasion causing supply chain disruptions and driving up the price of commodities such as gas and oil. Tech companies that have offices in the country have also suffered business disruptions as a result. It has also caused issues for tech startups.
“[The] Ukraine crisis affects the demand for various startups’ solutions depending on what they sell,” Henriksson says. “For example, companies with Russian customers will see massive declines in renewals of subscriptions to software products if credit cards do not work.”
These factors have contributed the perilous situation on global markets. US Federal Reserve officials have warned that the highest inflation rate in 40 years may be coming. Similar warnings have been raised across the globe.
Across the pond, the Bank of England predicted that the UK may suffer a recession before the end of the year. However, the UK Office of National Statistics released figures this week that suggest that inflation has already hit levels not seen since 1982.
Will tech investors stop investing?
“So far the market downturn has been most apparent in later stage companies and listed markets,” says Sarah Barber, CEO of Jenson Funding Partners. “Earlier stage companies are less susceptible to global stock market shocks in the near-term, but economic turbulence will inevitably have an impact over the medium and longer-term.”
The market downturn could end up hurting tech startups’ investment prospects. So far the investment slowdown has been reasonably slow. However, that doesn’t mean that growth capital backing hasn’t started to dry up.
“For the next 12 [to] 18 months, it will be more challenging to fundraise for startups than in the favourable market environment of the previous two, three years,” says Tom Henriksson, general partner at VC firm OpenOcean VC.
That is saying something. VC investment into the technology industry has grown every year over the past decade. “Technology has been growing through the roof for a while now,” confirms Jonathan Boyers, UK head of corporate finance and vice chair at KPMG.
Back in 2012, the global technindustry raised $7.5bn in VC money across 1,941 deals, according to data from research firm GlobalData. In 2020, that figure had jumped to $198.1bn across 14,493 deals. In 2021, that figure jumped to $497.7bn across 20,454 deals.
So far the industry has only secured VC funding to the tune of $141.4bn across 7,351 deals. This means it is still set to beat the funding levels seen in 2020.
What happens next?
VC watchers believe global market uncertainties will encourage tech investors to be more cautious about betting on startups and to do more due diligence.
"There is going to be a bit less money available, just while people are nervous," Boyers says. "Where projects look risky, [where projects in the past] have had the benefit of the doubt, particularly from a valuation point of view, Just because the whole market has been so [heady], I think we might see a bit more cautious valuations."
That being said, none of the experts we spoke with believe tech investors will stop betting on startups. However, they note that startups' ability to raise cash may differ depending on what stage they are on.
"The best investors recognise that great companies are often started in a downturn, so they invest with conviction at rational valuations and have prepared ample reserves to protect their portfolios," Tirtey says, arguing that early-stage startups will continue to thrive if they can demonstrate their ability to keep operational costs low.
Looking at Series B and Series C raises, he believes they could struggle to raise due to a "a combination of substellar year-on-year growth, unit economics, and high [operational costs]."
"Finally, late-stage valuations are tumbling," Tirtey says. "We are seeing deal terms become increasingly tough, including requests for a minimum 20% annual return on pre-IPO funding."
It’s not all doom and gloom: small early-stage companies with fewer overheads will continue to remain agile and will have a greater ability to navigate the rapidly changing markets.
Investors always look to exit, either with the company they're backing getting acquired or going public. However, there has been a marked slowdown in initial public offerings (IPO).
Consultancy firm EY noted in March that there was a 37% decline in the number of IPO deals in the first quarter of 2022, compared with the preceding quarter.
Speaking about the results in March, EY global IPO leader Paul Go said the decrease wasn't "unexpected when compared with Q1 2021 as the latter was the most active quarter in the last 21 years."
He warned that the "shock from geopolitical tensions and other economic concerns in the second half of the quarter created volatility and impacted the capital markets."
Since the volatile market conditions don't seem to be going anywhere, "there is a risk that IPO activity will continue to slow further with IPO candidates choosing to postpone their transactions," Go added.
"It’s not all doom and gloom: those small early-stage companies with fewer overheads will continue to remain agile and will have a greater ability to navigate the rapidly changing markets, which may prove an advantage against more slow-footed competitors," Barber argues. "As a result of these changes moving forward, tech investors will be drawn to these more agile companies operating with fewer costs and cushier profit margins until the markets start to get back on track."
This article first appeared on Verdict.