07 May 2020
Venture Capital across Europe has seen a rapid rise in recent years. However, given that VCs usually invest in companies with high growth and a significant cash burn, the global shut down will hit hard.
With that said many of the sectors and trends targeted by venture capital are particularly resilient and with more capital in the market than ever before deals will still get done – even remotely.
Given the uncertainty around the duration of the lockdown as well as the nature of the following recession – path to profitability is now a key concern of VC investors. While early stage funding rounds will still happen; significant emphasis will now be placed on cost control and capital efficiency as well as a plan to conserve cash if the downturn lasts longer than expected.
SaaS has long dominated early stage investing, and software will only become more sought after during this period. Investors are looking for very high recurring revenue, particularly with large, stable enterprise clients. Demonstrating value to your end client base will also become an extremely important metric to reduce churn as end clients look to cut costs across all sectors.
Obviously affected sectors such as travel technology may have a very difficult time raising funds. The key will be communicating early with existing investors and taking advantage of the various government schemes. Other sectors that rely on either consumer confidence or SME solvency may come under increased pressure from investors to demonstrate that they are not seeing a significant increase in churn or customer acquisition costs.
Valuations were nearing all-time highs across most sectors in venture capital towards the end of 2019. Funds are likely to be significantly more conservative when doing deals in the coming months.
This will likely mean that businesses that do not have to raise will delay funding growth until the end of 2020 or the beginning of 2021. Businesses that need working capital will first look at internal funding rounds to prevent significant shareholder dilution.
Given the difficulty of forecasting accurately during this period, we expect a rise in convertible loan notes over straight equity deals. This will allow both parties to push valuation discussions further down the road to when some semblance of normality returns.
The factors mentioned above will create value for opportunistic investors and those with the confidence to press on in trying times. Many funds have significant dry powder and will look to get back to business sooner rather than later.
Having said that, funds will find it difficult to complete sufficient due diligence in normal time frames to get deals done quickly. As a result, it is vital that businesses that need to raise capital in the next six to twelve months start early to make sure they don’t become cash flow constrained and find themselves having to raise from a position of distress.
Venture stage companies should beware of onerous terms in funding rounds for the foreseeable future. While the need to protect investor’s downside risk is understandable, raising with large liquidity preferences and other aggressive instruments may make it harder to raise capital in the future.
For advice on funding from new or existing venture capital relationships for your business, or to explore funding opportunities across any source of capital please contact the team.