The venture capital (VC) and private equity (PE) industry have invested heavily in the technology sector, from seed investments in new ideas to buyouts and take-privates of established businesses.
Having customers who pay a regular subscription to use the technology, which leads to a contracted recurring revenue base that is easy to forecast, offers downside protection and a growth model that is easy to finance. This business model is incredibly attractive and has led to fierce competition among investors and consequently, very high historic valuations for tech businesses.
But what are the implications of the coronavirus crisis for all this?
1. Tech companies are resilient but there are risks
In the wake of coronavirus, the downside protection of the tech business model will be tested. For many software providers, growth in subscribers will grind to a halt for at least a few months and, for businesses to survive, that recurring revenue will need to recur.
Software subscribers are often signed up multi-year contracts paid annually in advance and, as companies in the UK resort to honouring all but the most essential outgoings, it remains to be seen how many customers will pay, defer or default.
Many software products have indeed become essential to their subscribers, particularly as they work remotely, so providers of business-critical software look set to be some of the most resilient businesses in the market.
2. VC and PE funds are active and supportive investors
As a rule, VC and PE funds take significant equity stakes in businesses so they can actively contribute to the company’s development during their ownership. The markets are incredibly volatile at the moment and VC and PE investors will for the most part focus on their portfolio companies rather than make new investments, until some stability returns to the economic outlook.
This means investment executives are on hand to help their management teams cut non-essential spend and focus on cash. While top line growth is a challenge, companies will need to ensure their cost base is appropriate and cash burn rates are minimised.
PE executives are also skilled at dealing with other stakeholders in the business such as lenders and creditors and they are able to put more money into businesses should it be required.
3. Raising new capital will be challenging
In the near term, VC and PE investors will be largely focused on supporting their portfolio companies, so new deals and funding rounds will be a rarity in the coming months and those that complete will likely not achieve the heady valuations or favourable terms seen last year. It is also likely that a larger proportion of funds will be diverted to further funding portfolio companies rather than doing new deals as companies require longer to reach profitability.
The uncertainty will create opportunity for bolder funds to take advantage and VC-backed businesses that adopt a slower sales growth profile to hit profitability earlier may prove attractive targets for tech-focused PE funds.
For more information please contact Charlie Jolly.