By Robert Whitby-Smith, partner at AlbionVC
The pandemic has hit companies of all types and sizes hard. For young tech businesses, it could spell disaster if the impact on growth extends into 2021.
Lockdown has been a tale of two halves. Companies selling mission critical b2b software, Zoom being an obvious example, are flourishing as digital transformation has accelerated a number of years. We have seen this in our portfolio (AlbionVC focuses on b2b software) with many portfolio companies growing significantly since lockdown.
However, companies serving consumer-facing sectors, including travel and leisure, have seen major declines in revenue. The furlough scheme, which provided a temporary lifeline, is being phased out. VCs have a significant amount of capital to deploy, but investment decisions are not easy in this environment.
And this is likely to get worse. The UK economy is in a lockdown-induced recession already. However, whilst many are talking about the shape of the recovery, we think there will be a “second wave” of recession in 2021 as the impact of the lockdown feeds through into corporate budgets and investment levels and unemployment impacts consumer spending and confidence– an unpleasant scenario for companies struggling to grow and reliant on further fundraising. Inevitably, companies with great tech in a weak position will face opportunistic bids from Big Tech.
How to survive
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Young tech businesses in need of a funding solution to make it through the worst of next year have a number of options to consider.
Few will qualify for bank lending, and the Coronavirus Business Interruption Loan Scheme was not designed to support young tech companies. Venture debt is an option for some with a VC investor.
Few will qualify for private equity – who typically require a company they invest in to be making meaningful profit. Fewer will qualify for the Future Fund which requires specific match funding, excluding EIS and VCT. Given retail investors (under the EIS and VCT schemes) provide the vast majority of funding for early stage tech companies in the UK this will not be suitable for many tech startups.
Fewer still will have sufficient scale for an IPO to be feasible, which leaves venture capital and angels. VCs and angels back growth. Many companies are considering a small top up funding rounds from existing investors combined with some cost cutting to give them runway to Q1 or Q2 2021 when they plan a bigger raise.
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We think this is a risky strategy given the potential for bad news in H1 2021 (on healthcare and economic fronts). We would suggest companies seek to meet face to face with suitable VCs as soon as possible and build a relationship whilst there is the option. An external round may be possible now, or failing that, an enhanced internal round (with a new external investor) is likely to be a better option than a smaller internal round.
If lockdown or the subsequent second wave recession has hammered growth, then it will be hard for VCs and angels to build conviction. There will be an increasing array of examples of companies unable to raise money and being forced to sell out. A low price will be extremely painful for founders and early investors – but it may be the only viable option.
If you have to sell, how do you avoid a lowball offer? Having as much time as possible before you run out of cash will strengthen your position. Appointing a great corporate finance adviser to develop the story, identify great buyers and create competitive tension will help. However, another key foundation of success in the b2b software sector, which many do not devote enough time to, is building strategic partnerships.
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The ability to develop successful partnerships is often a critical success factor in scaling a b2b software company. The larger partner benefits from the innovation and differentiation from the tech scale ups product and in return helps scaling in many ways: perhaps developing and refining the joint value proposition, perhaps integrating with its products, or perhaps a channel to market and potentially the delivery resource.
In addition to helping grow revenue, a strategic partner may offer investment and may at some stage decide it wishes an exclusive relationship. If there is a strong relationship, it will not be a lowball offer. It is no surprise to us that most successful acquisitions of b2b software companies come from partners. A few examples from our recent exits: PSE, Grapeshot and Atego all built successful partnerships with Siemens, Oracle and PTC respectively where acquisition was a natural evolution of a strong relationship.
Partnership at the right time
When is the right time for tech scale ups to engage with partners? Firms should be careful not to start engaging with strategic acquirers too early as each relationship takes up a lot of precious bandwidth and many will not work out. As a simple rule of thumb, we have seen it is hard to build strategic partnerships effectively with an organisation of less than 50 employees.
However, whilst it takes up significant bandwidth and it may be harder to build new relationships in a world of Covid restrictions, young tech companies should resist the easy option of delaying developing these long term relationships.
In the current environment and with a bleak economic outlook for 2021, those that get ahead will be best placed to survive the rough headwinds in 2021 and thrive.