Duet Partners
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Weekly Briefing Note for Founders

21st September 2023

This week on the startup to scaleup journey:
  • Startups must now raise cash for survival
  • European M&A now outpacing the US

Startups must now raise cash for survival

In Elad Gil's authoritative paper on the outlook for startup funding earlier this year, he asked, "When will companies run out of cash?" The conclusion; "Many companies are about to meet a hard reckoning. This is likely to start by the end of 2023 and accelerate through end of 2024 or so. It is based on when companies last fundraised at scale and how much runway they raised." Many startups raised 2-4 years of runway through 2021 and early 2022. Those that missed the peak and then hit funding headwinds may have only secured limited bridge funding instead. A company typically needs to fundraise when it still has 9-12 months of cash left and this explains why so many are now busy planning and launching campaigns. Energised by the summer break and the news that valuations at Seed and Early Stage across Europe are showing real resilience (as we highlight below), increasing numbers of founders are dusting off funding plans that were put on hold months ago. These are now being 'recalibrated' for the very different funding environment that has emerged and then carefully 'road tested' with selected investors before the big push. This effort, driven by the pressing need to raise more cash for survival, is demanding levels of preparation last seen in serious 2018-19 campaigns, rather than the quick-fire rounds of 2021 and early 2022.

Many have delayed new rounds due to valuation anxiety. But the true picture on valuation trends has now emerged and it varies significantly by stage and geography. Pitchbook's 2Q23 European Valuations Report shows that valuations at Angel stage and Seed stage have shown great resilience, hovering close to their record highs, whilst Early stage and Late stage have shown only modest decline. Europe's Angel-stage valuations have remained strongly insulated from market uncertainty in the first half of the year, registering a 10% increase from 2022 to reach a median of €3.1M. Seed valuations have held flat with 2022 overall, at a median of €5.2M. On a similar basis, Early stage (typically A and B rounds) was down 11% and Late stage (Series C onwards) was down 13%. Analysts say that Angel and Seed rounds have been less impacted by volatility in the public markets due to their distance from exit, and we can see this in the quarterly data through 2022 and 2023 to date: Angel-round valuations have held steady since 4Q22, when they hit their all-time peak of €3.2M. Meanwhile, Seed-stage valuations hit their all time peak of €6M in 3Q22, then dropped alarmingly to €4M in 4Q22 before moving back up to €5.1M in 1Q23, and then up again to €5.4M in 2Q23. This is an encouraging trend.

For many startups in these formative stages that must now raise, the challenge isn't so much about valuation but deal volume. Comparing 1H23 with 1H22 across Europe, Angel deal volume is down 57% and Seed stage is down 50%. These numbers will improve in the coming months due to deal reporting lag. Even so, this decline is severe and reflects tighter investment criteria. But there is a growing contingent of founders that are confident that the time is now right to get out there. As we highlighted recently from our own research, this group broadly splits into 2 camps: 1. Those that had been considering a Series A round in 2023 but realise that this has become a rarefied space for all but the most exceptional propositions: Many have decided to reposition the 'A' round as a further Seed round instead, and 2. Those that have improved their Seed credentials in recent months. Many have reworked their storylines - based on more capital-efficient strategies and clearer risk-reduction steps - to fit a more conservative investment market. As a result, valuations at Angel and Seed are holding strongly as investors compete for a smaller number of higher-quality opportunities. In the UK, this has helped VC investment bounce up to £4.3B in 2Q23 from £3.6B in 1Q23, according to Pitchbook, which is the first sequential increase for 5 quarters. This is positive news for UK founders looking to raise in the coming months.

European M&A now outpacing the US

The value of global M&A slid lower again in 2Q23, even though the number of announced deals approached near-record highs, according to Pitchbook. Global M&A deal value fell to $873B in Q2, down 6.5% from Q1, for one of the weakest quarters recorded since the Covid-crash of 2Q20. On the year, dollar value was down 33.7%, and we are now 41.9% below the quarterly peak set in 4Q21. By contrast, deal count is relatively unchanged on the year and has declined by a less severe 13.8% from the 2021 peak. This push for the exits, even as prices decline, is a further indicator that the equity funding pathway - especially for late-stage companies still carrying inflated valuations - remains very difficult for some. In terms of pricing, the median EV to EBITDA multiple now stands at 8.8x for the 12 months ended 2Q23, down from 8.9x in 2022 and 10.5x in 2021, the all-time peak. The median EV to revenue multiple, more relevant for earlier-stage companies, now stands at 1.5x on a trailing 12-months (TTM) basis, down marginally from 2022 but down more sharply from 2021’s all-time peak of 2.0x.

What is driving this squeeze in average deal sizes beyond increasing supply? It's not the availability of cash per se. Both Corporates and PE firms, the 2 big acquirer categories, are sitting on massive piles of cash. The amount of unspent dry powder that has yet to be called and invested by PE stands at $1.35 trillion globally, just 9.7% shy of its all-time high. An even larger cash pile is on the books of corporations. In the US alone, cash holdings surpassed $4.0 trillion in 1Q23, just 3.3% below its all-time high. However, the 'value' of cash has increased as interest rates have shot up, and this is an asset that is being more closely protected. But there is a positive force as play that is driving acquirers into the market; with growth in corporate profits having turned negative for several quarters now, attention has turned to buying revenues through acquisition, where it cannot be developed organically. This is creating an active market for companies that are already generating (appreciable) revenues, but may be struggling to raise growth capital.

A comparison of European and US M&A activity reveals that a significant milestone has been reached. European M&A deal value in 1H23 amounted to $611B, down 28.8% versus the same period in 2022. On an annualised basis, the rate of activity in this first half of the year would imply that deal value ends 2023 23.1% lower than 2022. But despite this decline in value, projected deal count is holding reasonably steady at 8,887. For the same period, US deal value was much higher at $960B but on a similar deal count of 8,752. In other words, European M&A is now outpacing the US in terms of deal volume. That said, the US remains the undisputed champion of larger M&A deals, comprising 41% of $100M+ M&A deals in Q2, according to CBInsights. The decline in average deal sizes - even as activity levels remain resilient - indicates a greater desire by investors in European companies to head for the exit now, rather than apply more capital in the hope of better times ahead.

Happy reading!

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