Investment momentum across Europe is slowing

Global venture funding totalled $47 billion in April 2022, according to Crunchbase. This is the lowest amount invested in private companies in the past 12 months. April funding fell 10% month over month from $52 billion in March and down 12% from $53.5 billion in April 2021. When Pitchbook reported 'buoyant' European Q1 figures 2 weeks ago, the warning was, "as the economic effects of the pandemic emerge and the cost of living surges across Europe - and as the invasion of Ukraine continues to cause uncertainty - 2022 could be a challenging year for companies across Europe."  With the April figure of $7.4B invested ($10.3B in April 2021) compared to March at almost $9B ($11B March 2021), the indications are that momentum in Europe is slowing more abruptly than anticipated. Big picture, this is a 'dip' rather than a huge drop, but confirms that the market has firmly shifted away from the record-setting peaks of 2021 when global funding doubled compared to 2020.

Following the trend from the first quarter, the largest decline in global funding is taking place at Late stage, down 19% YoY, with Early stage flat and Seed stage actually growing 14%. As the turbulence in the public markets has had a dampening effect on Late-stage financings and valuations, and with VCs changing their investment strategy as a result, investors are showing keener interest in Seed stage businesses where there could be greater potential for value upside. Preliminary valuation data for 1Q22 reported by Carta for the US market shows average valuations at Seed slipping only 5%, with Series A down a dramatic 25%, Series B down 8%, and Series C down a whopping 42%. The modest decline in Seed valuations tracks with conventional wisdom that the earliest startup rounds are holding up in pricing terms despite a market in decline. The sharp drop at Series A indicates that 'outlier' rounds — in size terms — are becoming far less frequent here and are reverting to the norm. We have yet to see European valuation data for 1Q22 but expect the trend to follow the US market as we move through Q2.

What should founders take from all this? First of all, don't panic. Investment levels are still elevated compared to pre 2021. And even though there is a cooling off in new VC funds being raised, the major VC funds have good levels of dry powder. What we are experiencing is a global 'correction' that is the natural comedown from a multi-year period of frantic deal-making, abnormally boosted by Covid. We are quickly turning back to a market that values solid business fundamentals once again. Investors are more diligently assessing a fuller checklist of investment criteria, especially in the Seed to Series A transition. As a result, the pace of deal-making has slowed and VCs in particular are taking more time to evaluate potential opportunities. As reported in TechCrunch this week, "The pendulum always swings back. And in the case of startups, the move back toward saner pricing could wind up good for all parties — startups won’t raise at prices they can’t support, and investors won’t find themselves upside-down in so many deals."

CVC appetite for startup investment grows

As we highlighted in a recent insight, Corporate Venture Capital (CVC) is on the increase. Research undertaken by the Global Corporate Venturing Institute revealed that out of the 1,952 CVCs that made an investment during the first 15 months of the pandemic, ending June 30, 2021, more than 900 were making their first foray into CVC investing. That was a 51%/49% split between “veterans” and “rookies” participating in COVID-era corporate venturing. This survey has just been updated to include data up to March 2022. Results show the balance has now tipped and 52% of CVC investors were first-timers since the beginning of the pandemic (2,092 of 4,062 surveyed). According to Nicolas Sauvage, President of TDK Ventures, "this huge influx of new participants in the CVC space has stemmed from many corporations collectively recognizing the critical need for renewed agility and awareness in today’s dynamically changing world." In other words, collaboration with startups has now become a strategic priority for many corporates.

This building wave of 'strategic investment' means that CVC teams find themselves operating in an increasingly competitive landscape. More corporates are putting themselves about in investment circles as we highlighted in our recent article, Corporate investment in startups is booming. Just as for VCs, it's no longer enough just to be the provider of cash. Founders are now more discerning than ever and want to know what else the CVC fund will bring to the table - and in many cases they can bring a great deal: Foremost, the potential for paid-for commercial collaboration, but also a strong network, technical expertise, and of course, market insight. Providing there is clear alignment with the startup's core aims, such support can be a real accelerant. This value-add is often much more demonstrable than what many traditional VCs will claim to bring. So much so that this can create tension between the established VC community and some of the CVC upstarts looking to take an increasing share of the equity pie.

A recent article by Sammy Abdullah of Blossom Street ventures entitled " Strategic investors are NOT important" might hint at this dynamic. His analysis of 198 tech IPOs found that only 31 had a strategic investor. "The remaining 167 companies had only traditional VC or financial institutions as investors, but no strategics. In other words, having a strategic investor was not critical to making it to IPO for 84% of the companies we looked at."  The  criteria for this sample set was not stated, but includes IPOs going back to 1980! Abdullah adds "While there is certainly value in having strategic investors ... they’re not critical to success. What’s more important is to find investors that help when they can, are supportive (both financially and emotionally), and know when to step out of the way and let you do your thing." Founders will have to make their own judgement on the true value-add on offer and this may have a great deal to do with the sector and type of investment proposition. Low capital intensity software businesses, for example, may be less inclined to go down the CVC path. Startups seeking higher degrees of patient capital, such as those in DeepTech hardware, may find this is a vital route to survival though the early stages.

What to look for in a lead investor

Lead investors play a crucial role in funding. As rounds are often syndicated, especially at Series A and beyond, the lead investor brings efficiency to the process by 'catalysing' the deal: They corral the new investors behind a set of terms (the Term Sheet) and, on behalf of the syndicate, negotiate these with the founder. The lead investor will usually put in around 50% of the cash, but this can vary depending on the number of syndicate members. Some investors will prefer to 'follow'. Followers may not have the investment firepower to lead or, due to specific circumstances - perhaps they are located on a different continent - will prefer to be more passive. By looking at their investment history, founders should try to identify which of the investors they are targeting are likely to lead and which are more likely to follow. It shouldn't necessarily dictate the order in which investors are approached. A prospective lead investor may be more motivated to get behind a deal where several 'followers' have already expressed strong interest.

The lead investor can also smooth the due diligence (DD) process by minimising the degree of independent DD each investor needs to undertake. A competent lead can also reduce the friction that occurs between Term Sheet and the final Investment Agreement. This requires a strong grasp of legal matters (in the jurisdiction where the deal is being done) and the ability to manage the lawyers who will be responsible for the drafting. In deals where some syndicate members are based outside the UK, having a lead investor that has an established working relationship with a good UK law firm can be a huge benefit. Negotiating final agreements with overseas law firms or with a hastily appointed UK firm that may not be familiar with venture deals can, at the very least, create huge frustration. In some cases it can severely delay a closure - or even derail it.

Lead investors accrue an authority that comes with being the 'dealmaker', extending beyond that of a key shareholder and (most likely) board member. This combination provides a certain soft power that can be leveraged post-deal. Whilst all investors are owed the same duty, it's likely that the executives will be most responsive to those that have the greatest leverage. Some VCs will quickly try to position themselves as the prospective lead for this very reason. Provided they have a solid track record in this role and have the gravitas to act on behalf of other funds, founders should make the most of this capability. When building target investor lists, it is therefore important to ensure that potential lead investors are clearly identified and given priority treatment. Competent lead investors can be a huge asset. They can really smooth the process of dealmaking and make a founder's life a lot easier.

Happy reading!