A Guide to: Raising Capital in Uncertain Times

The macroeconomic situation

The combination of COVID-19 related supply-chain issues, rising energy prices stemming from the Russo-Ukrainian War and a tight labour market has pushed inflation rates to forty-year highs. A weak pound will push inflation up further as the burden of rising import costs will likely be passed on to consumers.

Central Banks are introducing tight monetary policies to combat inflationary pressures. The Bank of England has implemented steep interest rate hikes to 2.25% at time of writing and markets are pricing in the likelihood of a 100 basis point rise in response to the supply-side stimulus recently announced by the Chancellor. Similarly, the US Federal Reserve announced a 75 basis point hike to 3.25% on 21st September.

In the decade since the 2008 financial crisis, inflation has not been a major concern for investors. In today’s market, investors must carefully select asset classes to protect returns against rising inflation and price-in increased interest rates.

Impact on early-stage investment

A pullback in investor confidence has been observed. The S&P 500, for example, has lost 15.6% of its value since March 2022 and is at its lowest level since December 2020. The UK-centric FTSE 250 has lost 16.5% of its value over the last six months, the UK bond market remains volatile as prices strengthened in response to the Bank of England’s emergency GBP 65bn bond purchases and sterling fell to a record low on the morning of 26th September.

Valuation corrections have been widely observed. Unprofitable unicorns propped up by grand visions are suffering the majority of down rounds; in 2022, for example, 81 US companies raised at valuations lower than those used in previous funding rounds. Whilst depressed valuations have predominately occurred in the later growth rounds and IPOs, PE investors searching for financial or trade sale exits have to factor lower valuations into their ROI, which is applying pressure to their buy-side prices, meaning that VCs and early-stage founders are vulnerable to depressed valuations.

Rising interest rates are decreasing the availability of global liquidity and the markets are moving to risk-off, meaning that investors are becoming risk-averse when reviewing investment opportunities. Additionally, a higher proportion of companies will be looking for equity financing as debt becomes more expensive. As such, companies without robust business models and compelling stories will struggle the most when faced with greater competition for equity funding.

What can founders do?

Detailed due-diligence

MTP work alongside the leaders of pre-seed to series A companies to develop a detailed understanding of the vision for the business, helping with concept validation and business model creation and refinement. Our fundraise preparation service provides founders with a suite of documentation that support target angels and venture capitalists in making informed investment decisions. We help to present a compelling investment, with the explicit aim of enhancing our client’s chances of successfully raising their capital targets.

Capital efficiency and profitability

Founders should prioritise capital efficiency and accelerated break-even points. The age of ‘grow at all costs’ and subsidized growth at the expense of profitability is firmly over. Investors will be looking for businesses that are able to achieve strong profitable growth and companies with high burn rates and negative bottom lines will struggle to attract meaningful investment.

Strategic spending

Not only do we believe that lean business development is the only approach to building sustainable and scalable businesses, but increased interest and inflation rates will force founders to approach spending far more strategically. MTP work cooperatively with our clients to create lean and efficient businesses that prioritise profitability and scalability to present to our investor community.

It’s not all doom and gloom

Founders looking to raise early-stage capital should remain positive. A by-product of risk adversity and decreased deal quantum is the existence of USD 3.2trn of dry powder held by private investors globally as of Q2 2022. Whilst they may become risk-averse, inflation forces investors to execute investments that protect the value of their capital, meaning that there is still funding to be won in the market for founders who can position their companies as a vehicle to returns when investors are sceptical and growth is hard to find.

Inflationary pressures force investors to find and select investments and sectors that offer meaningful returns. Broad-based market indices offer between 5 to 10% average returns. The S&P 500 offered average annualised returns of 9.87% between 2001 and 2022 and the FTSE 250 returned 7.71% on average between 2005 and 2022. Investing into early-stage companies, on average, is the only strategy that provides an opportunity for a significant multiple on invested capital, albeit with some inherent risk, and protect against inflationary pressures.

Attractive investment targets will be companies that hold high pricing power command, and can pass inflation-led higher input prices onto consumers without adversely influencing demand, and those that provide recession-proof products or services.

The UK Government has recently announced significant improvements to the SEIS/EIS scheme to promote investment into UK start-ups. UK-based founders are able to raise under the improved SEIS scheme immediately, so long as shares are issued after the 6th April 2023. The improvements to the SEIS scheme unlock a greater quantum of SEIS assured capital for UK early-stage companies and further incentivises investment.

Notable improvements to the SEIS scheme include:

• Companies can raise GBP 250k under SEIS. They were previously capped at GBP 150k.
• SEIS now applies within the first three years of trading. It was previously two years.
• The gross asset threshold has been increased to GBP 350k from GBP 250k.
• The personal investor limit has increased to GBP 200k. The cap was previously GBP 100k.

In sum, there is still a considerable amount of capital available. Early-stage companies raising funds simply need to find the angle and story that fits the current market thesis in their sector.

If MTP could help you or your business or you want exposure to a reviewed pipeline of digital investment opportunities, please contact the MTP team.