‘Uncertain’ may be an appropriate word to describe the economy in the coming months, and the trajectory it takes depends on the outcomes of several key events such as who the next prime minister will be, how long the war in Ukraine will last, and whether a recession will occur. Such uncertainty creates challenges for startups. It seems that early-stage businesses most likely to survive would be the so-called ‘camel startups’ - those companies which know how to optimise resources to outperform competitors.
The Conference Board, a not-for-profit economic think tank, believes a period of stagflation, rather than a recession, to be more likely over the next 18 months, implying low economic growth and high inflation. GDP growth in the UK for 2022 is forecasted at 3.7%, and is expected to decrease to 1% in 2023 (compare to GDP growth in 2021 of 7.4%). Inflation is forecasted to reach 18.6% in January 2023, which interestingly enough is higher than in 1979 following the second OPEC oil crisis, when inflation reached 17.8%.
How do early-stage businesses generally tend to fare in stagflationary environments, given the associated risk of failure present even in the best of times? From a historical perspective, looking at the stagflationary economies of the 70s and 80s, high inflation in 1979 decreased by 2.1 percentage points in one year and continued its decline in 1981 (as per the Office for National Statistics). Thus, stagflation created a tough environment for startups. Many small businesses failed as they were outpriced by more established players; struggling to pay back loans with floating interest rates, and being unable to obtain new loans from the banks. Today, with equity financing being more accessible, early-stage firms thankfully have more options. However, access to finance does not resolve the challenges caused by rising energy prices. Based on a survey of 750 CEOs and C-suite executives, most believed that two of the largest problems they will face over the next year will be energy price volatility and rising input costs. Furthermore, geopolitical uncertainty, as well as the recent poor performance of public equity markets, have also had an effect on liquidity events of companies or company exits, in particular IPOs. Many firms have delayed IPO plans for more certain times, demonstrating further knock-on effects to the Venture Capital sector.
How do these factors affect investment in early-stage businesses? In the first half of 2022, UK Venture Capital investment was up over a billion pounds compared to the first half of 2021, but the volume of deals was lower as VCs focus now on later-stage investments, and devote more time to their due diligence process.
KPMG’s Venture Pulse report suggests that High Net Worth investors are stepping in to fund early-stage ventures whereas institutional investors are stepping away as they reevaluate their investment decisions (and most likely their risk profile). This may be a positive sign for niche areas of investment such as EIS and SEIS, which provides tax incentives for private investors. For further information on such tax incentives have a look at Sapphire’s page on the tax reliefs available through investment into EIS and SEIS qualifying companies by clicking here.
It appears that in challenging times businesses need to innovate to adapt to new circumstances and, they need to be leaner to cope with rising operating costs. For startups to survive in such an environment, leanness and efficient use of resources are key, bringing the concept of the ‘camel startup’ to the forefront of our minds: a company that can cross this figurative ‘desert’ of uncertain times. Perhaps companies should look to focus on being camels, making survival and profitability their main priorities, and not worry about becoming unicorns. After all, a company must first survive before it can grow!
Sources:
https://www.conference-board.org/pdfdownload.cfm?masterProductID=39487&tpcc=nltermsheet#page=11
https://databank.worldbank.org/reports.aspx?source=2&series=NY.GDP.MKTP.KD.ZG&country=WLD
https://www.ft.com/content/778e65e1-6ec5-4fd7-98d5-9d701eb29567
https://www.ons.gov.uk/economy/grossdomesticproductgdp/timeseries/ihyp/pn2
https://fortune.com/2022/06/23/startups-vcs-should-be-preparing-for-possibility-of-stagflation/
https://fortune.com/2022/06/23/startups-vcs-should-be-preparing-for-possibility-of-stagflation/
https://home.kpmg/xx/en/home/campaigns/2022/07/q2- venture-pulse-report-global.html
https://home.kpmg/xx/en/home/campaigns/2022/07/q2-venture-pulse-report-global.html
