Market Intelligence

The blindness of smart money hinders fundraising among “second-tier” start-ups

By 25 February 2021 No Comments

The health crisis of COVID-19 and its seemingly never ending reign has reached its one year marker. At this point, it is only expected for startups looking for capital to raise some pressing questions during these unsettling times, such as: Has there been a stop to fund raising in 2020? How is the risk associated with COVID-19 affecting valuations in a fundraising or selling situation? Why do some managers talk about a Q5 2020 and not a Q1 2021? The outpour of uncertainty is overwhelming.

And yet, despite the times, major French startups including Qonto, Alan, and Lydia are entering the world stage of 2020 through spectacular fundraising operations. These operations were made possible by top tier investors, such as Tencent, DST Global, Index Ventures, Idinvest, Bpifrance, Daphni, and Kima Ventures. These companies, while different, have three characteristics in common: they are veritable « killer apps », they are a 100% Fintech, and, they are followed by tier one investors. The question then raised is, what about other startups in other sectors? What about the less visible and encumbered companies suffering due to the general slowdown of the economy?

Truthfully, the go-to startup valuation models haven’t been adjusted by investors to match the times. The metrics stay the same and precision is amplified due to the risk of a correction in the months to come. Within the profession, and in the best practices, investors insure themselves in order to invest when economic indexes are good. For instance, the Life Time Value over the Cost of Acquisition of Clients enables them to measure if the startup will generate more returns than what they spend. The devastation of COVID-19 remains unchallenged.

In general, the valuation models in 2020 aren’t simple. The universal slowing of economic activity challenges the viability of the currently used business models. Meaning, the number of potential deals in tier one tends to shrink, and all other sectors become no man’s land; unexplorable in an unprecedented situation. Consequently, the already not fully established startups become even less visible, and their opportunities to be in touch with a venture capitalist are limited. Ironically, the differentiation of their offer to investors becomes more common of a concern, even if most claim to be overloaded by startups searching for capital.

Incidentally, money continues to flow in excess due to some investors still offering money to startups, even if they aren’t fund raising. Nonetheless, the introduction of smart-money differentiation in the value proposition of each investor becomes crucial. Nurturing the deal-flow of start-ups committed to raising funds and increasing the chances of participating in promising financing rounds is a priority. The relationship between investors and entrepreneurs is slowly returning to a balanced state. The investor now becomes the partner of the entrepreneur in identifying the signs of growth of his company, opening up their address book and becoming less demanding in terms of governance. What then is the sticking point for Tier 2 or Tier 3 start-ups, that seemingly are omitted from this new trend? Why are the new relationships promised by investors under the “smart money” hat struggling to multiply? Could it be the health crisis and the wait-and-see attitude it provokes?

In part, yes… but this is not the only reason. Smart money is a mode of rebalancing strictly reserved for companies that are courted on a daily basis due to the expected gains that are well above valuation standards with minimal risk. Today, Fintech is the “flagship” sector for this type of service. In the coming years investors will turn more to greentechs, cleantechs and sectors with new mobilities. As discussed at the Alternative 2021 seminar, organized by Preqin, COVID-19 will continue to spread like the private equity industry. We are in a slowdown of inbound transactions, i.e. new fundraising, not a full blown stop. The level of “dry powder” (uninvested funds) is growing increasingly higher and while the number of fundraisers has decreased in 2020 the value of exits and the amount of transactions on the secondary market (exchange of securities already issued during past fundraisers) have exploded. 

The latest industry trends demonstrate that European venture capital investors are lagging behind more active US investors in closing new deals (deal origination). Moreover, the field of investigation and approach techniques, used by European investors have reduced and consequently caused them to miss the great investment opportunities in start-ups. Indeed, the scouting process is often misunderstood and regulated to routine exploration of the industrial ecosystem by traditional approaches, ones that give little room for new technologies. Smart money is certainly a more effective approach to the market on the part of the investor, with respect to sometimes timid entrepreneurs, but it does not solve the problem of sharing the systemic risks taken in each entrepreneurial adventure.

Delphine Monti

Author Delphine Monti

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