The C19 funding gap is damaging European Start-ups

Technology has been a booming industry across Europe in recent years. The emergence of Covid-19 (C-19) has already prompted a notable decline in the sector, which is particularly stressing components of the industry. However, technology has provided us with the means to most effectively survive this unprecedented crisis and will also provide us with the opportunity to rebuild our economies post the crisis.

With concern growing in the UK at the lack of a coherent governmental structure to support the industry, this article reviews the role of technology in the C-19 crisis, the challenges that early-stage technology companies are facing and potential solutions that are being pursued at governmental level across Europe.

Technology is helping us through the crisis:

With C-19 driving a lock-down across much of the European (and global) market, technology has played a key role in enabling us to find new ways to operate and communicate. It will play a key role in managing the virus and helping us emerge on the other side. Yet challenges to the technology eco-system, if managed incorrectly, could undermine our ability to bounce-back from this period of lock-down.

During lockdown, technology has played a key role in enabling society to find a new norm. With virtual meetings becoming the established working method - Teams, Hangouts and Zoom (US) are simultaneously the enablers and beneficiaries of change. Whilst in our private lives, we have come to rely heavily on Amazon and e-commerce providers for necessary goods; so too we turn to WhatsApp, Netflix and the ubiquitous Houseparty (who hasn’t joined?) for socialising and entertainment. People who have previously never used technology to interact with others are now using it as a daily norm, in both business and social lives, and these changes are likely to stick.

The technology sector is also taking a leading role in helping society deal with the challenges presented by the virus – by communicating health messages, identifying a vaccine, or tracking the spread of the virus across the population. GPs are leveraging technology to establish video consultation and diagnosis of patients. It is hard to know how and when we will come out of this state of lock-down, and indeed what the new world will be like, but we can be sure that the role of technology in society will have changed and will have a key role to play in our futures.

Technology needs to be part of our exit strategy from the crisis:

Looking forward we feel that the technology industry will also have a vital role to play in rebuilding our economies. Technology companies are likely to be more adaptable to the post-C-19 world than more traditional businesses. They will have the capacity to provide new well-paid roles in high growth industries that will help our economies bounce back from what could be a painful recessionary period. We may also find that the changed world requires a new modus operandi, building from our current experience, which technology companies are well equipped to support.

Yet many of the companies that might underpin this revival, particularly younger businesses without the financial reserves to get through this time, may not survive the lock-down. The risk is, without sufficient financial backing at this challenging time, the early-stage technology sector could see multiple businesses fail prematurely.

C19 is causing a technology funding crisis:

At Kobolt, we work with a broad range of companies. We have observed that, anecdotally, a lot of the earlier stage businesses we work with have come under substantial pressure in Q1 2020. Without deep financial reserves, well-established partners and revenues to fall back on, they are being forced to strip costs back to all but skeleton functions and employees. Clearly, this does not position them strongly for growth, and some may struggle to survive.

To be clear, these are not businesses that are operating in industries that are long-term stressed (e.g. retail, consumer), but are businesses operating in high growth markets suffering from short-term funding issues exacerbated by the global pandemic.

Of course, there are some early-stage companies who are winners today. Those who are wise and/or fortunate enough to provide a product that fits the specific needs of today’s market or have already secured very substantial funding rounds are well positioned for growth. Sadly these may turn out to be the exception.

Many of these businesses, which would have traditionally been considered sound investments and might have followed the same trajectory as that historically pursued by many of today’s technology leaders, may not receive funding and may fail. These businesses, still typically in cash-burn situations, would normally look to private investors, as well as VC and private equity groups, to raise funds to support their scale-up and growth. In the current scenario, however, funding is scarcer, and a lot of these businesses are in danger of closure.

Investment is currently risky and so funding round volumes have dropped:

In talking to the VC and broader investment community, the good news is that the message from circa 80% of them is “we are still open for investment, but the bar for new investment has been raised”.

The market is open, Kobolt are actively working with a couple of businesses to help them secure their next stage of funding and there is active interest from VCs. Yet, whilst there is clearly no shortage of capital, in practice many funds appear to be focusing their efforts on shoring up the balance sheets and operations of their portfolio companies to suit this new environment.

When we look at the data around new funding rounds, we can see that the volume of rounds has declined dramatically in March 2020 compared with like for likes in 2017, 2018 and 2019 (data from Crunchbase). There are still notable funding rounds, for example in the UK Cazoo announcing a $100m round, ThoughtMachine an $83m round and Lilium in Germany announcing a $240m round, but these are the outliers.

Where the drop in volumes is most marked is in early-stage businesses across Europe, where funding rounds between $1 and 5m are down over 50%. Should this trend continue for a period of months, many younger businesses will suffer.

When we consider the uncertainty in the world today, it is hardly surprising that funding from traditional sources has dried up. It is also very difficult to value businesses given current uncertainties. Feeding money into businesses facing this outlook could be a risky approach.

For brave investors there could be the opportunity to invest in fundamentally good companies that are stressed due to this unprecedented situation, and potentially to do so at a much lower cost than three months ago. However for many investors, hunkering down until the world has rebalanced and there is greater certainty appears to be the preferred approach.

Is government intervention necessary at this time?

Germany has taken steps to deal with this funding gap by announcing a €2billion start-up booster for German technology businesses through their Federal Ministry for Economic Affairs. In practical terms the Ministry has announced plans to match 30:70 investments into the start-up sector (VC:government funding). This pragmatic approach in aligning government investment with VCs should help de-risk their equity investments and ensure capital is still funneled into the right businesses.

The Economic Affairs Minister of Germany, Peter Altmaier, commented “We are using €2 billion to expand venture capital financing, so that funding rounds for promising, innovative start-ups in Germany can continue to take place. In this way, we are safeguarding innovation and jobs in Germany.”

France has also established similar programs comprising €4 billion of capital backing for the start-up tech sector.

In contrast, whilst the UK government has made the right noises “The Coronavirus Business Interruption Loan Scheme” it has established is seen as unlikely to serve the specific requirements of the technology sector. A movement started by the Chairman of Seedrs – Save Our Startups – backed by many of the leading CEOs and investors from the UK technology sector is demanding more action from government: “The UK Government must act now to protect Britain’s entrepreneurial future so we do not lose a generation of start-ups and high growth businesses to COVID-19”.

It will be interesting to see how the UK government responds to this demand and how other European governments react to their own challenges over the coming days and weeks.

From our perspective, it feels like money decisively and well-invested in the early-stage technology sector today (ASAP), whether through private, governmental or hybrid funding structures, will underpin the industry over the coming months and bring much needed long-term benefits as we look to the future. The correct investment will also enable society to capitalise on the changed use and role of technology as we emerge from this crisis.

We will revisit the topic over the coming months and explore how both governments and investors have reacted to the C-19 funding gap.

In the meantime, we wish all our readers good health and best wishes.