By Miguel Fernandez, below, CEO and Co-Founder of Capchase
You don’t have to be Nostradamus to predict that next year is going to be a challenge for businesses. We are undoubtedly entering a global recession, but the shape, scale and length of it is hard to gauge. The tech industry is arguably at the vanguard of this economic uncertainty. Many companies have already begun layoffs and there has been a noticeable drop in investment activity. Many commentators have pointed to the tech bubble bursts of 2008 and 2000 as indicators of what might happen over the next year. The mantra at the moment seems to be, ‘prepare for the worst’. However, this position is overly cautious. There is actually a lot we do know that can provide insights into what might happen next year and it isn’t all bad news.
For tech, we need to look at what has changed in the sector compared to 2008. The short answer is: nearly everything. Fourteen years ago, Europe’s startups focused predominantly on consumer tech: like hospitality and travel platforms or apps, or some small areas of fintech, mostly around cross border transfers and payments. Now, tech is an intrinsic part of every industry. Investment levels and valuations are unrecognisable. For context, in H1 of 2022, European tech companies raised €60 billion across 2,608 deals. In the entirety of 2007, funding hit a record of €7.5 billion: an amount it would not reach again until 2012. The startup community has grown from a niche network of professionals to one of Europe’s largest employers.
All of this is to say that using the 2008 recession to prepare for the 2023 downturn is misguided. The tech sector is much deeper and broader. As such, we aren’t going to see the uniform collapse of previous bubble bursts. The impact of this recession already looks very uneven – tech-enabled businesses, particularly those with a consumer focus are struggling. On the other hand, pure tech businesses, for example, SaaS , cybersecurity and martech are largely continuing to grow.
Another key difference is that the startup scene is not solely reliant on VC capital to fuel growth these days. In 2008 the collapse in traditional sources of funding meant that new startups struggled, failures were exacerbated and growth severely curtailed. Crucially, viable startups were caught up in the storm, requiring them to make deep cuts which damaged their businesses and made recovery difficult – and in some cases – impossible. Not only did this prolong the recession, it helped cause a domino effect which impacted much every tech vertical.
Today founders have the ability to access a large and rapidly growing alternative financing scene. There are scores of companies offering numerous ways for viable startups to continue to get capital and allow them to weather the storm. Traditional finance is also very different. Previously, getting a loan from a bank was essentially out of the question for many startups, now it’s a real option. Although many alt finance startups get their capital from VCs, most have built up huge war chests of credit over the past few years.
VC funding is going to continue to retreat in 2023 and valuations will also fall further. This means entrepreneurs will have to give up more equity to close significant VC-backed rounds. For early-stage businesses with good fundamentals this financing route will be particularly unattractive. As such, alt-finance and other forms of debt are going to play a much bigger role in the growth stories of many startups. We may see a new generation of startups that reach maturity in the next five years which have largely avoided taking cash from VCs.
The growth of alt-finance has also been driven by a realisation by many businesses that different sources of funding should be used for different purposes. We are increasingly seeing longer-term capital, such as equity and long-term debt, being used for bets and initiatives with uncertain returns, like new product development, research, and entering new markets. Whereas cost-effective non-dilutive capital is being deployed for user activation and working capital.
There is also likely to be a large uptake in smaller, purpose-specific financing solutions. Businesses will take short-term debt to execute tactical plays to safeguard their business during the recession. This could be to shorten sales cycles, improve client conversions or sustain ongoing marketing and sales activity. The growth of alt-finance will naturally spark more innovation in 2023. A major trend we expect to see is the rise in technology solutions with modern UX to underwrite and monitor at scale. AI will also play a bigger role – enabling more in depth risk analysis and ongoing monitoring.
If all goes well we should see Europe’s tech industry start to exit its recession towards the end of next year. However, VC funding will take a lot longer to reach the levels we experienced in 2021. When it does recover, the tech funding landscape is going to be completely different. The alt-finance sector will be markedly larger, it will be the source of a significant innovation within fintech and it will be playing a key role in the growth of the next generation of tech giants.