The startup investment market has changed around the world. It put an end to the million-dollar rain that propelled the sector to record levels in 2021 (that year venture capital invested $643,000 million in it, compared to $335,000 million in 2020). Inflation, rising interest rates and the war in Ukraine have alarmed investors who have become more selective about the projects they invest in, causing the entrepreneurial ecosystem to slow its growth while the economy shrinks and heading towards a possible recession .
The situation has resulted in startups facing important challenges. And some examples illustrate well what happens. Klarna, the fintech The value of deferred payments, for example, rose from $46,000 million to less than $7,000 million in a private funding round earlier this month. And only Getir, which specializes in express shipments, and Klarna laid off 4,480 and 700 employees, respectively, in May.
Investments in Spanish startups also fell 30% year-on-year to 744.9 million between April and June 2022 after a better year-on-year first quarter of 2022, according to the Bankinter Foundation’s Startup Ecosystem Observatory.
The notion that startups won’t be able to raise money as easily as they will in 2021 is taking its toll on many fledgling companies, which are beginning to feel the pressure. According to Layoffs.fyi, a layoff tracker in the tech sector, layoffs at these companies rose 350% globally in May. And he expects European startups to cut their hiring by up to 80%.
“Capital activity will slow down due to economic uncertainty, but we don’t know if it will be for a quarter, two or more. Funds have become more cautious; they only invest in projects that they see very clearly and that will not change until they find a scenario that allows them to see what is going to happen,” says Miguel Kindelán, head of investment bank GP Bullhound in Spain.
For this expert there is no doubt that once these economic players have dispelled their doubts, since the amounts of money raised by these funds are record-breaking, the investment will pay off. “This latent investment exists and is used because this money is raised and has an expiry date. They have made a commitment to their investors to invest and sell within a certain period of time. The question,” he admits, “is at what valuation levels will they invest when they go back to normal.
Layoffs at these companies surged 350% in May, according to tracker Layoffs.fyi
In his opinion, there will clearly be adjustments, “because the public and private markets are communicating and we are already seeing the valuations of listed technology companies falling.” But there is more: “We have seen a clear investment trend in recent months: Investors go to more profitable companies and not those that burn a lot of money to grow very quickly.”
Kindelán points out that the sectors that suffer the most are those of software “which stems from a very high increase in their valuations” and those of electronic commerce and deliverywith startups that burn a lot of money to grow, like Getir, Gorillas or Instacart, and that are badly affected by the inflation outlook, which will lead to lower consumption”.
Despite the investment delay, the head of GP Bullhound warns that the market is not closed and funding rounds are continuing. As an example, he cites that of EcoVadis, a provider of corporate sustainability ratings, which last June raised 500 million in an operation in which his bank acted as financial advisor.
José del Barrio, co-founder of the fund from venture capital pan-european Samaipata also believes there is still “fairly good” investment activity despite the economic uncertainty. But he admits they see two speeds: “Later startups, the ones making rounds starting at $20 million and $30 million, are the ones that are closing far fewer deals. On the other hand, among those from the earliest stages, there is still a fairly good level of activity, although it is noted that there has been some impact on the score.”
For Ignacio Moreno, co-founder of the fintech Capchase, there was “a perfect storm” affecting the sector. “In addition to the above issues, there are others such as the energy crisis or supply chain issues… High interest rates have never favored tech companies because they fully impact their valuation. And its impact, which is already being seen in the public markets, is beginning to be felt in the private markets, where it usually arrives a bit late.”
Moreno, in line with what the Samaipata co-founder pointed out, highlights that investments in large startups are virtually paralyzed. “In Serie A they’ve been paused about 50% and in Serie B 60%, but in the seed or pre-seed phase the phenomenon is much less noticeable. These types of companies are already making big bets and this is not going to stop. You have to remember that many companies that are huge today were founded in times of crisis, such as WhatsApp, Groupon and Uber, which started in 2008.”
And it points to a problem some startups are grappling with. “Those that have raised rounds of funding at very high and inadequate valuations will need to grow to meet their valuation if they are to avoid one round down (a funding round in which the valuation is lower than the previous round) as happened to Klarna.”
Kindelán and Del Barrio agree that there are opportunities in a scenario like the current one. “There are very good companies that are going to try to fund themselves on market terms that they won’t reach and they will end up funding themselves at very attractive valuations and these are opportunities.” According to Samaipata’s co-founder, 2021 saw many startups’ valuations soar as a lot of capital poured in, leading to what is likely to be an unhealthy valuation inflation; now we are going back to a similar situation as in 2019 and 2020,” he says.
Other possibilities Kindelán points to have to do with talent and acquisitions. “There will be startups that will be able to acquire attractive companies that fail to raise capital to grow stronger and get better valuations. In fact, there are funds that, when investing in a company, prefer that money be used for inorganic growth because it’s less risky that way.”
In terms of talent, he points out that with all the layoffs that are happening in the industry, there is a lot more talent available in the market, “so for startups that are in an expansion phase and that have a growth bottleneck due to the lack of Talent, it’s a great opportunity”.
In any case, according to the co-founder of Samaipata, one has to be careful in the current macroeconomic environment, because the drop in investment is not massive, but the beginning of a longer-term change. “We advise the companies in our portfolio to expand runways (the number of months they can continue working without another cash injection). Usually there is talk of 12 or 18 months, but now it is certainly preferable to go to 24 or even 36 months because there is a lot of uncertainty and it is better to make sure that they can reach the other side of the Rubicon.”
The three experts surveyed show which sectors they believe can overcome this investment brake better. Moreno assures that at Capchase they are staunch supporters of the SaaS (Software as a Service) sector “because it’s more resilient because it’s a B2B”. Del Barrio also relies on verticalized SaaS (“highly scalable platform models”), applications of artificial intelligence in various industries and proptech, related to the real estate industry. For his part, Kindelán believes that startups focused on sustainability issues are a clear trend.
Invest more rationally. The head of GP Bullhound in Spain warns that investing “more rationally and conservatively” can pose risks due to economic uncertainty, as investors could turn their backs on companies with riskier models, “and the disruption usually comes from those more original and disruptive models. “
ecosystem sustainability. Despite the fact that the pace of investment is now slowing down, Miguel Kindelán warns that never before has so much money been raised predestined to invest in this type of company. So when the clouds clear, “they will invest again.” According to the person in charge of GP Bullhound, the money already raised from the funds allows the system to be financed for more than two years, “which is a guarantee of the sustainability of the ecosystem. But on top of that, we hear every day from funds that continue to raise money,” he says.
“Venture Debt” and bridge rounds. Experts agree that market volatility will increase the need for alternative sources of finance. Many companies use this Risk Debt (a mixture of debt and Equity capital) as a non-dilutive financing option. Other startups do bridging rounds at the same valuation as the previous one, which is usually done by existing shareholders, “which is good to make sure you weather the storm,” says Ignacio Moreno. His company Capchase also finances startups with a SaaS model. based on your future earnings. They are presented as an alternative to venture capital and traditional debt.