So far 2019 has seen a record year for VC funding, with $4.9bn capital secured in H1 according to a recent report by White Star Capital. The UK’s focus on tech has played a big role in the growth in the popularity of crowdfunding also. Where between January 2016 to June 2019, over half of seed deals were crowdfunded. The two biggest platforms Seedrs and Crowdcube have been a financing channel for over $1bn of early stage and seed stage investments in UK start-ups.
Optimism is in the air then for the time being, but with the potential for turbulence on the horizon for the UK economy. Therefore, we want to take a step back and consider the landscape for early stage funding in the UK for the next eighteen months. With yield curves inverting around the globe and in the UK for the first time since 2008, many financial and economic commentators are fearing an imminent recession. The yield curve is a potential indicator of an oncoming recession, and an inverted yield curve has predicted seven out of the last nine recessions. It is agreed however it is not a perfect indicator, with several economists claiming quantitative easing (QE) has distorted the bond market.
If a recession were to happen in the near future, early stage funding may take a hit, due to the increased perceived riskiness of early stage ventures. They are riskier because of the lack of traction and revenue metrics companies will be able to evidence during their early stages. VC’s may hold off until future prospects are more certain, and the level of risk involved in investment is reduced.
In a recession, a few things happen in the public markets which transpire to the private markets, impacting venture funds. First thing typically to happen is that multiples compress, meaning that VC’s may see smaller potential exits and thus need lower valuations to get the same return, leading to an increased number of flat or down rounds during a recession.
Next, LPs (Limited Partners) become over allocated to venture as an asset class. During the recession, the value of an LPs entire portfolio drops significantly but because venture funds are very illiquid, and the amount of capital committed to venture as an asset class remains constant. Meaning that as a percentage, venture often times goes above those thresholds and LPs stop investing in new funds making it harder for VCs to raise their next fund.
As VC’s are aware of this effect, they become increasingly conservative in allocating the capital they have. This in turn makes it harder for the general start-up to complete a fundraising round. Companies that have strong metrics may still get funded, but a lot of other contenders that could have raised money in a strong economy may be rejected during the recession.
It is hard to make recommendations, as we never know what the future holds, but we believe to be successful as an early stage company, recession or not, it is imperative to have the following:
- Provide realistic valuations
- Evidence of traction:Strong traction data represents your product/service is being demanded by your customers, where a proof on linearity in traction growth is a extremely positive sign.
- Distribution channels: Distribution channels are key. If a start-up has working distribution channels in place already, the valuation and the subsequent raise will be easier than without them
- Testimonials: Evidence that customers are satisfied with your product/service are very beneficial
- Team: The team is a huge factor for us. A well experienced and knowledgeable team is a huge plus, as well as technical founders. A solid team can obtain a higher valuation, as they are more likely to lead the company to success in the future
Innovate UK, which has formed a partnership with 11 private investment firms, is offering grant funding of up to £2m alongside equity investment for R&D projects taken up by immersive tech businesses. The immersive industry in the UK specifically is being targeted by Innovate UK as it is estimated to generate £660m in sales every year, and company’s incumbent in the immersive economy have employed as many as half a million people. However, in spite of this, there exists a gap in angel and early-seed investment into immersive tech businesses, a crucial point for the growth of new business. Therefore, with grants like Innovate UK, aimed at encouraging early-stage private investment into SME’s, they may exist a helping hand during times of economic downturn.