The party is over in tech. For now. And the impact will be felt by all of us who need to raise capital to finance our businesses, in non-tech industries and tech alike.
In our first “Three Things Ask an Expert” podcast, All Together talks to Steve Schlenker – Founding Managing Partner at DN Capital – on what’s been happening to tech stocks in the US, what it means for UK start-ups, and why every early-stage venture needs to act urgently to maximise cash reserves and extend runways.
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Over the past few weeks, some of the biggest names in venture capital in the US have published the advice that they are giving their portfolio companies (links below). While their assessments of the revaluation of tech stocks in public markets ranges from ‘a welcome adjustment’ to the ‘bubble finally bursting’, the universal conclusion is that loss-making scale-ups need to urgently rethink their plans. Gone is the annual fund raising at ever-increasing and mind-blowing valuations. Instead, they advise everything from instigating a freeze on new hires all the way to planning and undertaking significant cost cutting. The details of the advice differ, but the objective is the same: reduce burn rates and lengthen the time until the next fundraising, or even better accelerate to profitability.
In the US stock market, “FAANGS” are down 30% from their March/April peak, recent IPOs down 50-70% and SPACs (including UK startups Arrival and Cazoo) down a whopping 90%.
Steven Schlenker’s CV //
1995-99: Investment Advisor – SUN Group
2000-present: Co-Founder & MD – DN Capital
Various Board member roles including Yottaa, Robin Systems Inc, Parallel Wireless and Auto1.
This conversation has only reached the mainstream in the UK market in the past few weeks, and the impact on scale up businesses has so far been limited. A few term sheets have been pulled. A few big name companies have announced cost cutting (e.g., Klarna). And some are now aiming for profitability instead of hyper-growth (e.g. the super-fast delivery market).
Make no mistake, winter is coming.
To get a clearer understanding – and to seek out advice for our members – All Together called US expert Steve Schlenker, Founding Managing Partner at DN Capital who heads up DN’s office in Palo Alto. A seasoned investor who has seen three major downturns, including the original dot com crash of 2000 era.
Quick off the mark, Steve begins with a calming explanation of the inevitability of bubbles deflating and inflating in tech, and that the underlying story is one of long-term progress and value creation. That said, the scale of this deflation is significant and fund raising in 2023 and 2024 will be tough.
In a chilling reminder of the COVID crisis we have barely left behind, Steve – and many other US commentators – are talking up the need to survive, then thrive in this latest economic challenge. His advice? To maximise your chances of survival, you need enough cash and the right plan to cover the next 24 months without needing to raise new funding.
Listen to our whole conversation here to find out why you should be concerned, and what you should be doing to arm your business today.
Steve’s Three Things to survive then thrive the coming storm
Fill your coffers now – as much as you can
Structure your business and your funding today so you don’t need to raise capital in 2023 and ideally 2024. For example, to maximise your cash balances in the next few months you could
Pull in a bunch of angel investors, on simple terms, even though you really want VC money
Give customers discounts for upfront payments and long term contracts
Slow down. Lower growth ambitions could materially reduce burn rates.
Get smart on cash management
Find smart ways to reduce your costs. For example, you could
Secure new business partnerships, thus opening up new sales channels, and allowing you to reduce the size of your direct sales force
Introduce salary sacrifice schemes for top management. Not only will this reduce costs, but it will encourage and nudge behaviour throughout the business, lowering expectations at pay reviews and lowering salaries for new hires.
Switch to gorilla marketing campaigns to reduce Facebook and Google ad costs
Revisit and update your strategy
Use this moment as an opportunity to reflect, and rethink your business strategically. How can you better position your business, both in terms of product line and markets, and how you organise your team, so that when the markets do come back, you come out stronger? You may sacrifice short-term growth with major changes to product portfolio or market strategy, but if it leads to greater acceleration of your growth in 2 years, then it is a strategy best suited to these unusual times.
All Together’s View
The effect of the Great Tech Revaluation will be felt far and wide. 2023 could very well be a bloodbath, but this isn’t just about tech companies.
We have seen a steady increase in valuations of non-tech startups in the UK over the past five to ten years, fuelled by a genuine increase in the supply of good startups and experienced founders, and inflated further by the generous support of SEIS and EIS. Consumer product businesses achieved tech style valuations. Revenue multiples ruled over EBITDA as the preferred measure of valuation. These times are gone. For profitable businesses, and businesses with high (not hyper) growth, traditional EBITDA multiples are back. For those in hyper growth, revenue multiples are coming down to their lower, historic levels.
While there is still cash available for investment right now, we are no longer in a founders market. Investors will have their power back, and prices– valuations – will adjust accordingly. Fundraising from the back end of Q3 2022 will become super hard. Beyond that, down-rounds will be back, and business failures are inevitable.
Our advice? Follow Steve’s plan. Be the most entrepreneurial you have ever been in securing new ways of adding cash. We are in crisis management again. Close funding rounds now – and don’t argue the details. Change operating plans. Revisit strategy. Focus on fewer investments. Moderate growth ambitions. Trim people and admin costs. And undertake the analysis and preparation for large scale cost cutting just in case. Develop a plan that sees you survive 2023 and 2023, with lower ambitions if need be.
The good times always come back, but only the most entrepreneurial will both survive and thrive the coming winter storm.
The best of you will thrive during this time period too. And when markets are back, and in an upswing again, you will be positioned to win and win big.
All Together’s Volunteer Advisors offer their time pro bono to small business leaders for exactly these moments. When times get tough, an independent sounding board can be invaluable. Apply here and we can connect you with one of our advisors: www.alltogether.company/apply
To listen to the full podcast of this conversation, head to Spotify, Apple or any other platform.
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Further reading: What other US investors are saying
To get a sense of other advice US VCs are giving their portfolio, try out the blog posts and presentations below from leading US investors:
Y Combinator issued a “Batten down the hatches” missive to their portfolio, with a 10 point plan focusing mostly on survival. Recommending companies “plan for the worse”. Like Steve, they argue that you need to know how you will survive the next 24 months.
Andreesen Horowitz’s deep dive in to managing this downturn through detailed analysis of valuations, burn multiples and scenario planning. Key message: “Raising capital with less than 23 months of runway sends a negative signal to the market and makes it harder to have a good fundraise”.
Sequoia have the gloomiest of outlooks, as demonstrated in their presentation to portfolio companies “Adapting to Endure”. Calling the current environment a “Crucible Moment”, there is an underlying pessimism in the economic situation, with the cost of capital rising fast and with so “many of [the monetary and fiscal policy] tools having been exhausted”. Urging founders to “confront reality”, they urge companies to “do the cut exercise” even if not yet pulling the trigger. They then proceed to demand companies shift from ‘growth at all costs’ mentality to ‘consistent growth’ and, of course, path to profitability. On the positive side, so many companies with hiring freezes mean the talent pool is to become deeper and recruiting should become easier.
Lightspeed Ventures choose to focus on the positive with their blog “the upside of a downturn”, and how to use the more challenging times ahead to “redesign your organisation around quality of people, not quantity”, and to “hone your business model”.
For general background, try the following two articles:
The Sunday Times piece, “The great tech ‘revaluation’ has only just begun”
Inc.’s “Prepare your Business for the Coming Capital Crunch”.