Deal terms and high growth: deciphering market trends
From what investors are investing in, to the trends that are emerging in a difficult funding environment, the panel unpacked deal terms and priorities in the high growth and VC marketplace.
Deviations from the norm, longer funding times, US investors: what should companies be aware of?
Matt Vaughan, EVP of Strategic Partnerships and Corporate Development at LawVu says that by and large, it is harder to raise capital in 2024 than it may have been in 2021-22, unless a company happens to be of the type that is attractive at the moment, such as those dealing with generative AI or LLMs.
Adina Goga, Director of Legal at Dawn Capital, says that AI company valuations are extremely high, even “insultingly high”, for companies that have little to no revenue and still expect a lot of money on the table. She adds that this also applies, to a lesser extent, to companies in the tech and fintech spaces.
“From a company perspective, when it comes to raising capital, we're seeing now that conversations are harder, they’re taking longer and there are different questions being asked”.
Matt Vaughan, EVP of Strategic Partnerships and Corporate Development, LawVu
What this means for GCs that may not be in those lucky fields is that they need to be “hyper-aware” of deviations from the norm -- such as investors seeking terms that may give them more leverage over the start-up? -- and support founders by providing sound judgment at a time when emotions can be high as the company tries to get funding. Matt recommends that GCs be proactive with their investors, asking questions throughout the process, and creating an environment where they get to have the “maximum negotiating power”.
US investors are also taking the opportunity of a perceived downturn in the UK and Europe spaces to create competition. But Sarah Stafford, General Counsel at Passion Capital, and Alex Richardson, Partner at Taylor Wessing, advise that their term sheets can be the furthest away from the established norms of the BVCA, often with unclear future side effects for a company that might not be seen without “digging under the surface”, so they advise caution on Stateside investors.
“There are things that you really need to query and push back on. It doesn't mean that that [a US] investor isn't the right investor, it perhaps just means that they don't invest in the UK too often, or they've not done their due diligence on the key things that need to be implemented here,” Alex says. “Some of that negotiation can be lost in a more difficult market, where people are just so excited to get term sheets. But that’s where all of us [lawyers] can really add value to those relationships with founders”.
Tough funding environment: a welcome correction and opportunity for creative thinking
Sarah, says that her fund, which supports companies through the pre-seed and seed stage, had not found a difference in the regularity of deals, their valuation, or their speed has not changed too much, but admits that the “frothiness” of the pandemic has come down and that this has been a god thing for funds like hers.
“Some correction was inevitable, and actually quite welcome for the entire ecosystem,” Sarah says, adding that her fund was being pushed out of seeding valuation rounds by funds focused on the latter stages of funding which were offering “crazy amounts” for early-stage deals.
Nevertheless, she says that the downturn of funding, in general, has meant that companies are struggling with not too many term sheets being presented to them, as well as investors being tough on valuation. The situation has also meant that it has been harder for maturing companies to get through the A, B and C funding rounds.
Alex says that she has heard that “the flat round is the new up round” and that companies will need to reframe their thinking: flat rounds don’t mean that a company is going backwards or failing, but are rather a reflection of the current market. She also says that this can be a welcome time for companies to think of other ways to grow, such as through acquisitions. “Companies need to be a bit more constructive and think imaginatively about where opportunities are,” she says.
The dance of valuation, and what to do if you can’t get funding: convertibles in the spotlight
Adina notes that she has seen companies having the upper hand when they can point to two other term sheets that might be willing to give them the valuations they want, while Matt argues for companies to be a bit more sensible in their approach so as to not become “zombie companies that are chasing headlight numbers”, potentially risking staff layoffs and project cuts.
In a tough funding environment, companies have been turning more and more to internal rounds, convertibles or bridge financing to stay afloat, particularly if their last funding came before the pandemic, and they are struggling to raise capital this year, Alex says. The panel discussed that this type of funding can be good for a company, particularly if current investors recognise that it ought to be getting bigger valuations. If they see that, following a convertible, a company tightens their belt and does what they ask, they might be willing to inject some cash into the business until the funding environment improves, or until a new project generates more revenue, making the business more attractive.
“From the company's perspective, maybe it can feel like there's too many questions, things are taking too long, and they’re being asked to do too much. But overall, I think it will be good for companies. If they can do [the due diligence], before we even get involved, that is a plus”.
Taking advantage of the downtime, longer funding times
Matt advises that this might be a good time for companies to “be proactive and cleaning up the skeletons”. It can also be a good environment in which to get teams together to make the due diligence process as easy and simple as possible for investors, once they do come.
Sarah says that her fund has been asked to do a lot more diligence, which has meant discovering more issues; a positive, she says given that these might have not been picked up in a more intense funding environment.