NEWS

Sharpen your Pencils

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Ivan Farneti, Expert in Residence for Seedcamp and long time venture investor, has shared his thoughts on a recent article published by the New York Times, looking at how European startups, like the US, are beginning to feel the pinch, with lower valuations and new capital becoming harder to come by.

The New York Times article, titled “European Tech Scene Begins to Feel Silicon Valley’s Woes”, was making the rounds across social media this week and was picked up in the Seedcamp office too, where the team has definitely started to see signs of this happening.

This Economic slowdown certainly isn’t great news, but this is hardly a surprise. It is not the first time we have seen this correction in Europe’s tech scene. For those old enough, this is the third time.

The signs are always the same. Public stock markets falling, tech IPOs trading below issue price, 50-100x revenue valuations by private markets (therefore private company valued much higher than public market peers), non VC-expert/trained money coming in (Hedge Funds, Family Offices, Corporates), US investors flying to Europe not just for holidays, and, at a micro level, more companies raising very large rounds on unproven metrics and fundamentals.

The first time the US tech market fell big it took Europe more than one year to follow suit. The second time it was faster, just six months later. This time, it is happening in tandem with the US.

This is not the time to run for the hills. This is the time to be found ready and get pencils sharpened on both sides of the table.

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Startup CEOs should have gotten the internal memos and calls by now. Budgets and business plans are normally signed off in December and a first forecast may need to be prepared already, mainly looking at the rate of expansion for not-yet-profitable companies using more caution. New CapEx, new hires, new office openings etc. should be re-reviewed in the cash flow forecast, with an eye to when the business will need to get back to raising capital.

Down rounds may and will happen, and they need to be managed. Some drama is inevitable, but open discussions as early as possible can reduce it. Anti-dilution provisions (if in the shareholders agreement) may shift some value. If the size of the interim financing is not too big, the effect of the weighted average anti-dilution provisions could be surprisingly quite small. Expect fundraising discussions to take longer, due diligence to be more detailed, so it makes sense to be sensible and start much earlier.  Board discussions and legal/tax advice may be needed if, as a result of down rounds, option plans go under water and need to be cancelled and strike prices reset.

VC funds will need to review their reserve allocations, more critically and more frequently. Founders should ask about reserves to their investors, enquire if they can rely on any dry powder reserved against their company.  As interim internal rounds can be effective at bridging businesses without exposing valuations.

The good news is that these corrections do not last forever. Markets forget and forgive and bounce back. And focusing on efficiency and productivity for a while has never killed any company.

So be prepared and sharpen your pencils. Game on!

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