Funding for growth in turbulent times

Angelina Kuznetsova
Partner, Advisory Corporate Finance and FinTech Lead, Deloitte

Over the past year, the M&A and fundraising landscape has proven to be a formidable challenge for technology and FinTech enterprises in the United Kingdom. This challenge is substantiated by a discernible decrease in deal volumes across all stages, types, and deal ticket sizes. The prevailing investor sentiment has been notably affected by the global energy crisis, compounded by escalating inflation and diminished economic growth rates.

If you are considering fundraising or exploring options on how to finance growth for your business, we have observed the following nine key trends impacting the deal-making landscape and considerations for businesses looking to raise funds.

1. A decline in valuations, influenced by adjustments in public markets and the rising cost of capital, is creating disparities in the anticipated value between prospective buyers and sellers.
2. The lower valuation environment and cautious approach to deploying capital have resulted in more borrowers seeking less dilutive capital solutions, such as Venture debt and ARR financing - with overall debt volumes being heavily correlated to equity deployment trends. There is a wider pool of borrowers interested in these financing solutions, which is culminating in an increased number of lenders, deeper liquidity pools, and a more diverse product set.
3. In line with macro trends, the cost of financing has increased. While pinpointing exact pricing is difficult due to the mix of participants in the markets, which include; banks, family offices, and private debt capital (i.e. debt funds), we have observed pricing closer to 12% from as low as 7% 18-24 months ago. Additionally, fixed pricing has become much less available as lenders are more cognisant of interest rate risk management.
4. Investors are seeking an increased level of downside protection through deal structuring, i.e. deferred considerations, earn-out provisions, and minimum return hurdle rates.
5. There has been increased scrutiny over business plans with a greater focus on deliverability and certainty of management forecasts, accompanied by a rigorous bottom-up analysis applied to all key growth drivers, defensibility of market position, and margins.
   
6. Investors are placing a strong emphasis on future cash generation, seeking an accelerated path to cash generation and margin enhancement. Therefore, a reduction in costs is now expected, despite an increase in customer acquisition costs.
   
7. An appetite for bridging rounds has materially diminished, with investors expecting funding that is advanced enough to last to cash generation.
   
8. We have observed an increased number of internal funding rounds, with existing investors now more focused on supporting their portfolio companies rather than making new investments. As a result, full exits are being delayed until market conditions have improved.
9. Overall, transactions have been taking longer to execute and complete in the current environment, with a higher level of aborted processes.

Despite these changes and challenges mentioned above, several aspects of the current market environment set it apart from previous downturns and make it likely to lead to an increase in M&A activity. Early signs of this are already being observed:

• The UK economy is performing better than expected, with a mild recession expected in 2023 and a gradual recovery in 2024. Unemployment is expected to remain low.

• Private equity and venture capitalist funds have high levels of undeployed capital, which investors are keen to put to work to support the right opportunities.

• Private companies with strong financial KPIs continue to attract investors at high valuations, leading to highly competitive sale processes.

• Strategic investors are actively seeking M&A bolt-on opportunities, particularly in certain sub-sectors of technology and FinTech, which continue to consolidate. This is likely to provide an additional boost to deal activity and generate exit and investment opportunities for market players who are unable to raise funding from financial investors.

• For the foreseeable future, debt financing options available to the venture ecosystem are expected to remain healthy, and whilst debt volumes will continue to be correlated to venture capital deployment, we expect European debt market volumes to become a larger proportion of total capital as interest and market acceptance continues its upward trajectory.

• Once valuation adjustments reach a healthy equilibrium, deal volumes across the market could increase.

• Investors remain interested in certain businesses, specifically B2B enterprise software, especially those with strong SaaS metrics and KPIs.

We have observed early signs of market recovery and anticipate a pick-up in M&A and fundraising activities towards the early part of 2024. However, this may only be slowed down by the outcomes of pending US and UK elections as the market adjusts its expectations with respect to the potential changes to fiscal policies.

Throughout this turbulent period, four steps remain that should be followed to increase the chance of a successful transaction:

1. Preparation: Before starting the M&A process, it’s crucial to invest time in ensuring the company is appropriately prepared, for example, ensuring that correct documentation is in place and that the company’s growth strategy is agreed.
2. Warm up the market: Building relationships with potential buyers or partners before launching a formal M&A process can help to increase the chances of success.
   
3. Timing: This is key in M&A. Choosing the right inflexion point in the business’ growth can help to maximise the value of the transaction. This may involve waiting until the company has achieved certain milestones or has a strong pipeline of future business.
   
4. Business plan: Ensure the company has a solid business plan backed by historic KPIs, client wins, and a strong pipeline.
   

If you are looking to explore funding options to support your growth or are considering an M&A transaction, our team of specialists would be very happy to provide support. Please don’t hesitate to get in touch with us to discuss your options and how we can assist you in achieving your goals.