Unicorns in the Ravine:
Is Growth Losing Priority in Post-Pandemic Startup Funding?
From Airbnb to WeWork, the pandemic has rather embarrassingly revealed that when it comes to many growth-at-all-costs-orientated startups, the emperor has no clothes. But is this going to have an impact on how future funding is applied? Lucy Ingham hears from startups and VCs from across the global tech community to find out if it is time for a rethink of startup funding
A few years ago, at the height of the startup funding boom, it seemed that the only thing that mattered was growth. However, even before the pandemic hit, the cracks were starting to show.
This was most notably shown with co-working giant WeWork, which enjoyed billions in funding from SoftBank Vision Fund, before seeing a severe downgrading in value. SoftBank CEO Masayoshi Son has since branded the investment “foolish”, while managing partner Jeff Housenbold has said SoftBank now uses the startup as a case study for what not to do.
WeWork is by no means alone. Uber, once the darling of the tech world despite failing to provide a clear path to profitability, has seen its shares lose a quarter of their value. Airbnb, meanwhile, is in tatters, having lowered its internal value by 16% and announcing a swathe of layoffs.
SoftBank Group’s earnings call in May perfectly captured the situation, in a slide that has been borrowed by CEOs the world over: the once elegant unicorns have now crashed into the ravine, and only those that can grow wings will escape.
In many ways, these companies represent the hangover of an earlier investment age, where growth was king. But now in the cold reality of the pandemic, are we seeing this model finally meet its end?
Is this the end of growth-at-all costs?
Exactly what the current attitude to growth is depends on who you ask, but it is clear that many have changed their perception of its role in startup funding.
Amit Anand, co-founder and managing partner of Singapore’s Jungle Ventures, one of the largest VC firms in southeast Asia, argues that while “growth is good and dare I say even essential to the success of startups”, “It is the growth-at-all-costs mindset that has led to the recent, spectacular failures”.
“There is a generation of founders who don't know anything about building a business that can last without having an unlimited supply of capital,” he says.
“Their measure of success has always been keeping up the growth through often short-term oriented practices. I feel that failure of WeWork and some of the other high profile, so-called ‘role model’, startups were drawing attention to these issues, but the events of the last few months have certainly exposed the fault lines completely, and rightfully so.”
“There is a generation of founders who don't know anything about building a business that can last without having an unlimited supply of capital.”
Meanwhile, Olav Ostin, managing partner at venture capital firm TempoCap, believes that investors are “absolutely” going to place a greater focus on profitability in the future. However, he still sees growth as key.
“Personally, if a company can demonstrate that it can still grow in the current environment, then that is an incredibly powerful statement and a testament to their business and its viability,” he says.
“Strong growth is incredibly powerful, particularly now, and companies that are still growing will attract investor appetite. Being able to show growth in adverse times is always attractive.”
Others, such as Mike Jackson, entrepreneur success director at startup growth platform Tech Nation, reject that the growth-first model has been upended at all, arguing that “delaying profitability, and in some cases even revenue, until scale and market share has been secured” is essential in many cases.
“It worked for Facebook and Google and it’s working today for Tech Nation alum Monzo and Babylon AI, to name two,” he says.
From hyper growth to resilient growth
But growth can take many forms, and despite its lasting importance in startup funding, there is a sense that things are changing.
Arun Penmetsa, partner at Silicon Valley-based VC firm Storm Ventures, argues that while growth is certainly not dead, there is “more emphasis on building resiliency in an organisation and to better understand the risk factors”.
“In the short term, companies are focused on preserving cash given the uncertain state of the recovery and fundraising environment,” he says. “I think that focus will continue for a while. In the long term, growth still is vital, especially since public markets are still valuing growth.”
“In the long term, growth still is vital, especially since public markets are still valuing growth.”
For Chris Locke, CEO UK and Europe, of corporate innovation and venture development firm Rainmaking, which in June launched Rise, the world’s first virtual startup accelerator for departing employees, this is best described as “a shift in moving from growth to resilient growth”.
Stephen Page, founder and CEO of SFC Capital, however, sees the situation as more subjective to each company. He points to two world leading examples with very different approaches: Amazon, which “focused on growth and didn’t make a profit for many years” and Microsoft, which “was driven by profits”.
“At the heart of the matter I do not believe that any good investor will separate the two,” he says. “Almost every business will want to make a profit at some point. CEOs do not want to be constantly giving away more and more equity all the time. Investors will also not be interested in a company that constantly needs support through its life, they are looking to make a return.”
Accelerating a longer trend
While the coronavirus pandemic has certainly shaped the funding landscape for startups, it may not be as strong a driver of any shift that is occurring as it initially seems. Instead, many see the shift away from growth-at-all-costs to be rooted in an earlier time.
“We think the recent shift of focus from growth to profitability was underway before Covid-19 really hit,” says Matt Wichrowski, partner at European VC firm Fly Ventures, which in June announced its second investment fund.
“A reckless pursuit of growth-at-all-costs has been out of fashion amongst investors for some time now.”
“There have been a number of high-profile tech companies that have very publicly struggled to command the same multiples in the public markets. Those examples have had a significant impact in investment thinking, though that's much more pronounced in the later stages of venture.”
Kirsty Grant, chief investment officer at Seedrs, agrees with this sentiment, arguing that “a reckless pursuit of growth-at-all-costs has been out of fashion amongst investors for some time now”, adding that Covid-19 “has validated that approach”.
“As we’ve seen from our investor community, people continue to look for ambitious companies,” she says. “But as always, they want to see management teams that have sensible cash and resource management plans and the wherewithal and agility to pivot strategy quickly as circumstances unfold.”
Bringing the time to profitability forward
While a move away from a growth-only mindset may have deeper roots that the dawn of the pandemic, there are still aspects of startup funding that are inevitably being impacted by the economic downturn it has produced.
For startups looking to thrive the biggest change may instead be how quickly they will be expected to achieve profitability – a key concern for many investors.
Aman Behzad, managing partner at corporate finance advisory firm Royal Park Partners, for example, argues that while “revenue generation and growth” remains an unchanged focus, “the timescales with which investors expect to see evidence of eventual profitability” have shifted.
“For a startup, profitability is traditionally a medium-to-long term goal (four or five years from inception),” he says. “There is an increasing drive, however, to see profitability from year three, and sometimes even earlier. And whilst it is typically not necessary to generate actual profitability, demonstrating the ability to do so eventually is key.
“Growth and profitability are two sides of the same coin and the balance shifts over time.”
“This means startups that want to thrive need to place a sharper focus on strong, demonstrable unit economics sooner, rather than kicking it into the long grass as many have a tendency to do.”
Fly Ventures’s Wichrowski also sees “a greater focus” being places on profitability “in the later stages”.
“But within venture, we think that's mostly true at the unit level, not operational,” he adds. “It's still very likely to successfully list on public markets before net profitability is reached.”
However, profitability is by no means at odds with growth. Storm Ventures’s Penmetsa says that the two are intertwined, but during downturns profitability becomes “more important” to maintain business continuity. “It is also important that to realise that growth and profitability are two sides of the same coin and the balance shifts over time,” he says. “In the short term, I expect the balance to shift more to profitability especially in sectors like travel, hospitality, HR etc that are more susceptible.”
A healthier market?
This shift may cause concern for startup founders, but for some experts, it is a very welcome sign of a healthier startup funding market.
Jos White, general partner at Notion VC, for example, argues that the change “isn’t necessarily a bad thing”.
“Investors know that fast growth alone doesn’t necessarily result in a sure investment – companies need to prove the ability to innovate and grow efficiently,” he says.
“The pandemic may well result in much healthier startups, achieving more with less, with a greater focus on productivity.”
Jungle Ventures’s Anand, echoes this, saying that his company is “relieved to see the tide turn, albeit slowly” and adding that this will take pressure off startups from continuously engaging in fundraising. However, he does express some caution that this will translate into genuine improvements within the culture of startup funding.
“I am only cautiously optimistic that we all will learn from past failures.”
“Supportive institutional funds around the world have a significantly higher appreciation for the value of long-term investments as everyone has a renewed focus on sustainability and inclusiveness,” he says. “There is some light at the end of this tunnel, but I am only cautiously optimistic that we all will learn from past failures.”
There are also those that see this shift leading to a more scientific approach to investing and startup creation, such as Michael Niddam, co-founder and managing director at venture builder Kamet Ventures, which focuses on the health and insurance industries.
“Investors will need to be more assured than ever that the companies they are investing in will survive. Likewise, entrepreneurs will be looking to minimise their risk profile,” he says.
“As a result, I believe we will see the venture builder model become more prominent. Their scientific approach to validating business ideas weeds out all but the few with a real chance of not only surviving but thriving, having been heavily challenged on paper to begin with. Low failure rates will attract investors.”
Cash to burn: Investors still have money
Amidst these changes, and the severe economic impact the pandemic has inflicted, it is important to note is that it hasn’t drained the accounts of investors.
Christopher Kong, co-founder of Better Nature, a food startup focused on plant-based meat alternatives, describes the last few years as “one the longest bull runs in human history”, arguing that investors are for the most part “sitting on piles of cash that they’ve managed to accumulate over a decade of continuous growth”.
“As a result, though the coronavirus has been and still is a massive disruptor for the vast majority of businesses, many VC firms are currently finding themselves in a position to be able to write massive cheques,“ he says. “However, they will only do so for the most promising startups that fit their new investment theses that are adapted to the post-Covid-19 world.”
Isabelle O’Keefe, principal of early stage VC fund Sure Valley Ventures, agrees, saying that VCs are “still investing, albeit a bit slower”.
“Many VC firms are currently finding themselves in a position to be able to write massive cheques.”
“A lot of venture capital funds have recently raised $100m+ funds and have a lot of dry powder that they want to put to work and continue to be opportunistic,” she says.
Rebecca Burford, a corporate transactional specialist and partner at Charles Russell Speechlys, also sees “dry powder” being plentiful, aided by the growing presence of government support, such as the Future Fund.
“Although there will undoubtedly be a recalibration of valuation multiples and a renewed emphasis on due diligence, investors still have large amounts of capital to deploy,” she says.
This has been the experience of a growing number of startups, including Switzerland-based Alpian, which announced it had raised $12.4m in Series A funding in May for its high-net-worth digital bank. And although Schuyler Weiss, CEO of Alpian describes the funding environment “more challenging”, especially those who need additional funding every year, he does see considerable opportunities for those who can show profit lies ahead.
“We’ve found that investors have a renewed focus on companies with a clear path to profitability,” he says.
Different investors, different styles
While investors may be more choosy with their funding, there is not a one-size-fits-all response to the coronavirus when it comes to startup investors.
“Investors are engaging with potential fundraising in different ways. Some investors have put all of their new investments on hold to preserve cash to fund their portfolio companies if at all necessary,” says Justas Janauskas, co-founder and CEO at knowledge-sharing startup Qoorio.
“Other investors have increased the quantity of new investments, especially if they’re betting on a new normal. We’ve also seen some investors not changing their approach and behaviour at all.”
For startups looking to raise funds, what is key is the ability to stand out from the crowd.
“A company that is not exceptional and innovative will find it much more challenging to raise in this environment.”
“The great companies are still raising, and valuations are still very high, but I would say a company that is not exceptional and innovative will find it much more challenging to raise in this environment,” says TempoCap’s Ostin.
Tech Nation’s Jackson, meanwhile, is keen to remind startups that this is not the first recession that the ecosystem has weathered.
“It is likely that fewer startups will receive funding from angel investors but there have been similar contractions before, notably in 2008 when Tech Nation alum like Farfetch and Zoopla were started,” he says. “So I don't foresee any future shortage of world-beating digital tech scaleups over the next five years.”
Winners and losers: The startups set to attract investment in the post-Covid world
Despite all the cash that sits waiting to be claimed in investors’ bank accounts, however, the fact of the matter is that the coronavirus pandemic has ravaged some industries and seen others achieve expected surges in growth. In short, the economic landscape has changed, and the startup landscape is inevitably a part of that.
As a result, there are simply going to be shifts in investor priorities between industries, in much the same way that there have been changes in the profitability of certain verticals over others.
On the winners’ side, according to Jungle Ventures’s Anand, sits technology, thanks to the surge in remote working and the hurried scramble to embrace digitisation. And startups in this area are going to see improved investor interest.
“From being able to order essential supplies over online platforms to finding better productivity and work-life balance via work from home, these are all significant changes in behaviour and startups are at the forefront of this tectonic shift,” he says.
“I expect tremendous organic growth in most industries and teams that balance this windfall whilst still maintaining good business practices, as there could be another crisis round the corner, are the ones that will emerge as once in a lifetime value creators.”
“A danger lies in being short-sighted and believing that just because a company is virtual means it won't face some difficulty in Q3 and Q4.”
TempoCap’s Ostin also sees technology doing better than other fields, arguing that “startups with virtual business models, ecommerce, cybersecurity, gaming” will be less severely impacted than others. However, he does argue that this alone will not make a startup immune to damage.
“A danger lies in being short-sighted and believing that just because a company is virtual means it won't face some difficulty in Q3 and Q4,” he says.
“The likelihood is that, in the medium term, the spending power of consumers will be adversely impacted, and all sectors must be prepared for these specific issues in the second half of 2020 and into 2021.”
But while all companies remain on shaky ground, there are those that face a considerably more precarious time ahead. On the losing side, are the inevitable: numerous experts have pointed to travel, hospitality and retail as being at risk.
However, here the story again is not black and white; companies in these fields can succeed. As Ostin explains, while “there will be a significant learning curve for these businesses, those that are agile and innovative will be the most successful in the coming months and years”. SFC Capital’s Page echoes this sentiment, arguing that “good companies will still get funded, it will just take longer to convince investors”.
Think big and find an edge
While there is undoubtedly a divide between startups in different industries, the division is not just along industry lines. Those with less ambitious paths are also likely to be impacted, argues Royal Park Partners’s Behzad, as investors shy away from “middling unit economics and growth prospects” in favour of big potential wins.
“In a bull market, these would still be viable businesses,” he says. “But given the current market downturn, the increased importance of unit economics, and the sudden shift to focus on more short-term profitability, many of them are existentially threatened.”
However, this doesn’t necessarily have to be in one industry. Startups that have potential markets across a broad range of verticals are also doing better than their single-market peers, with engineering startup Lontra among those seeing the benefits.
According to Lontra CEO Steve Lindsey, the company “couldn’t have picked a worse time for fundraising” but has “been pleasantly surprised” by how much interest it has attracted.
“I put this down to the strength of the underlying technology and the high potential returns for investors,” he says. “Ours is an interesting business in that our machines are used in a range of essential sectors from food production to water treatment, and the type and spread of industries should protect us from a downturn in any one.”
Ultimately, it is companies that can demonstrate flexibility that are going to be the most appealing for investors that are looking for ways to protect a return. And this can be borne out in a number of ways.
“Many VC firms are currently finding themselves in a position to be able to write massive cheques.”
Storm Ventures’s Penmetsa points to “companies that can adjust their value proposition and product” in response to the newly remote world, while Rainmaking’s Locke argues that there “will definitely be greater scrutiny on elements such as mitigating the risk around supply chain to ensure you can still deliver product to customer.”
“[Startups need to show] how they build in diversification on revenue streams so you don't have a Primark moment, where the lack of their online presence caused their revenues to drop to £0 during Covid-19,” he adds.
However, profit is not the only factor in whether startups will attract funding from investors. Some are also seeing a greater focus on purposefulness among investors.
“Positive returns are the primary motivator for investors, but we have also seen the investor and business landscape become more purpose-driven as a result of the challenges we have all faced during the crisis,” says Alpian’s Weiss.
“Investors are increasingly looking to target businesses and opportunities that have an impactful social purpose, backed up by a profitable model. We expect this trend to continue across both institutional and retail investment sectors, as we move into the global recovery.”
This is echoed in the rise of social impact investing, which is dominated by VCs that prioritise socially responsible or environmentally beneficial companies. And there are some big names in this space.
Advice for startups
For startups looking to successfully navigate these intensely rocky waters and attract much-wanted funding, investors have myriad advice. And for many, this focuses on being adaptable to the changing reality that lies before us.
Fly Ventures’s Wichrowski warns that what lies ahead is a “very different market”, so paying close attention to meeting the changing needs of clients is key.
“In a recession client budgets will be frozen, corporate champions will be let go and contracts will be renegotiated, delayed or cancelled outright,” he says. “It's critical that you solve a top priority for your customers. New technology adoption in the enterprise will be significantly stunted unless a startup can deliver a clear, quick and/or significant ROI.”
Jungle Ventures’s Anand takes this idea of change further, arguing that founders need to “learn, adapt and guide change”.
“Ones that will be able to absorb information and act decisively will have an advantage as the next few years could be quite volatile,” he says. “The most successful businesses will also be those that have built teams that are aligned on a culture of collective good.”
For others, however, applying a sense of realism is also vital. While moonshots remain appealing, the most successful startups are likely to be those that can demonstrate to investors that they will prove to be a profitable choice.
For Oliver Holle, managing partner of early-stage specialist VC t, this means that while the fundamentals – “great team, strong market and viable product” – remain the same, startups need to be “realistic with their outlooks”
“Plan for the worst-case scenario and try to maximise your runway. Investors will appreciate your efforts to adapt to the current market situation.”
“The more you can prove your business case and help demonstrate a not-too-distant path to profitability (or at least healthy gross margins) the better chances of receiving the funding you need,” he says. “Plan for the worst-case scenario and try to maximise your runway. Investors will appreciate your efforts to adapt to the current market situation.”
This sense of value for money also extends to how startups are operating. Notion VC’s White argues that demonstrating that you are being careful with money is key to showing investors your company is worthwhile.
“My two pieces of advice to startups looking for investment during this time – and beyond – is firstly to ensure you’re thinking at least as much about efficiency as you are about growth and secondly, ensure your product, whether you are B2B or B2C, is lovable – and that it perhaps doesn’t rely too heavily on in-person contact!” he says.
This sense of caution also extends to startups’ approach to fundraising itself. Fintech startup Yapily, which raised £13m in a Series A funding round shortly before the lockdown, advises to make use of fundraising when it is an option, rather than turning to it when it is urgently needed.
“The financial impact of coronavirus will be felt by both investors and entrepreneurs. Startups need to maximise chances of success rather than chasing a valuation,” says Stefano Vaccino, CEO of Yapily.
“This means raising when they can, not when they need to. Because you never know what’s around the corner or what could happen in the future.”
However, growth is still an ever-present part of the challenge, with Better Nature’s Kong arguing that it remains a priority.
“In a world where large corporates still dominate many industries, the lack of growth is synonymous with death,” he says.
“The mantra ‘monopolise or die’ still reigns and startups must focus on building a monopoly or face being outcompeted by their peers or larger incumbents.”
Crowdfunding: An alternative option?
However, for startups that are struggling to raise funds amid the pandemic and its fallout, there may be another way: crowdfunding.
This is an approach that is increasingly being adopted by a number of startups, through platforms including Crowdcube and Seedrs that have already helped startups raise millions in funding.
On Crowdcube, for example, the average raised is £670,000. Craft beer company BrewDog holds the fundraising record on the platform, at £10m.
Startup crowdfunding has become so big that it has seen the development of an entire supporting industry, with TribeFirst, a marketing agency focusing exclusively on equity crowdfunding, among those playing a role. And according to founder John Auckland, the current state of affairs is only going to grow the use of crowdfunding by startups.
“I know that many startups will struggle to get a fair hearing from banks and the gatekeepers of other traditional funding sources. I’m biased, sure, but I really think that the use of crowdfunding will increase as a result of this funding logjam,” he says.
“Throughout the pandemic, we’ve seen communities spring into action, using crowdfunding to fund vital services like PPE production and food banks. We’ve also seen swathes of campaigns launch with the aim of helping local enterprises weather the storm.”
“I really think that the use of crowdfunding will increase as a result of this funding logjam.”
Auckland argues that this approach provides a vital option for many businesses, having enabled startups to survive in conditions where they would have otherwise failed.
“Crowdfunding has helped to stop countless businesses facing bankruptcy and forced closure from going under, with endless inspiring stories of local enterprises kept alive due to enthusiastic support from their customers,” he says.
“Post-Covid, I believe that startups will increasingly look to the crowd to make their innovative business ideas a reality rather than hoping for traditional means of investment. If the crowd is sold on an idea, they will open their wallet to make it a reality and offer support when times are tough.”
It also, he says, can play a key role in maintaining customer loyalty.
“Early customers who back companies in their crowdfunding rounds, and invest in them via equity crowdfunding, stick with them for the long haul and are their most loyal and vocal supporters,” he explains.
“For brands of all sizes, now really is the time to create truly meaningful relationships with their customers. In the new, post-Covid world, genuine affection from customers who truly believe in a business will be more valuable than swathes of fleeting, distant relationships based on quick transactions.”
Startups are vital to recovery
For startups struggling to establish and grow amid such chaotic times, the road ahead may look daunting. However, many see such companies not only as essential to rebuilding, but also well-suited to making the most of the current state of affairs.
“The nature of startups is to solve a problem with a tech solution that is scalable and can address large markets, so challenging times present opportunities, particularly for tech entrepreneurs,” says Sure Valley Ventures’s O’Keefe.
“The last few weeks have shown us that there is a rapid adoption of online and digital services and a shift in spending. It is unlikely that many of these trends will be reversed after the pandemic and so this poses the right environment for tech startups to succeed.”
For investors, meanwhile, this may also prove challenging, but there is promise ahead.
“Investing in startups has always been for the patient investor. When there is turmoil elsewhere in the public markets and low interest rates, early stage investment often sees new interest pour in,” says Seedrs’s Grant.
“We are seeing downward pressure on valuations as investors are, rightfully, expecting a longer and potentially bumpier road to exit, but we are still seeing strong and growing interest in the asset class.”
“Plan for the worst-case scenario and try to maximise your runway. Investors will appreciate your efforts to adapt to the current market situation.”
However, with so much of the economy upended, it is important to appreciate just how important startups are and will continue to be to the future economic health of their respective countries, and the world.
Startups are job creators at a time when many are facing the prospect of unemployment. They create new opportunities and revenue streams in long-stagnant industries. And they help create entirely new avenues of the economy that can ultimately flourish.
In short, we need startups to continue to be created and funded if we are to see a healthy recovery from what may prove to be the worst recession in almost a century.
“Amid the dire warnings of recession and mass unemployment it is critical that innovation and the spirit of enterprise which fund them, are supported,” says Terry Scuoler, former CEO of the Engineering Employers Federation and investor and board director of startup Lontra.
“Startups, high-growth IP and scale-up companies will be key to averting recession and ensuring a return to growth and employment.”
And while this is a tough time for any business to launch, early findings suggest that the lockdown may prove to have been a powerful incubator for new ideas. Web builder platform Zyro has found that small business launches have more than doubled compared to previous months; a trend that is expected to continue as the year progresses.
But perhaps most vital is remembering that this, too, will pass.
“It is important to remember that as in any economic crisis there are always emerging opportunities,” says Rainmaking’s Locke.
“It is easy to forget the likes of Airbnb, Disney and Microsoft were all started in the middle of a deep recession, as when the status quo is disrupted, customer needs change; barriers to entry are lowered and new business models emerge that existing incumbents are unable to respond to.”
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