The past decade has been good to the technology sector. The tech giants have grown to become the most valuable companies in the world and, in the UK, abundant venture capital (VC) investment in tech start-ups has spawned countless ‘unicorns’.
Those days may now be coming to a close. Rising interest rates have made high-risk, high-return investments less attractive, and the cost-of-living crisis means consumers are less likely to shell out for the ‘convenience’ services, such as grocery deliveries, that many high-profile start-ups provide.
“It’s been raining money on fools for too long,” tech billionaire Elon Musk said in May. ”Bankruptcies need to happen.”
But predictions of a tech market crash may be premature, venture capitalists say. After all, the digital transformation of the economy shows no sign of abating.
In the last decade, the tech giants have squeezed out almost all other contenders among the ten most valuable companies in the world. As of March 2022, investment company Berkshire Hathaway and US health insurer UnitedHealth are the only non-tech companies on the list. Investors have clearly believed Big Tech’s claim to own the future.
And recently, the UK’s tech start-up sector has been especially hot. Since the start of the pandemic to today, venture capitalists have invested £80bn in UK tech start-ups, more than the total investment between 2012 and 2019, according to data from Tech Nation. UK start-ups have raised more than £20bn so far this year, more than their counterparts in China, Germany or France.
But there are signs this boom may be peaking. In the US, the tech-heavy Nasdaq stock exchange index has plunged more than 30% since November. And, according to a report by US venture capital firm Sequoia Capital, the majority of listed tech companies are trading below their 2020 stock prices.
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The report attributes this to rising interest rates triggered by central banks in a bid to contain inflation. “Simply put, the world is reassessing how business models fare in a world where capital has a cost and reconsidering how much credit to give companies for profits many years into the future."
In Europe, meanwhile, venture capital funding for start-ups is projected to fall by 16% between the first and second quarters of this year, according to market research firm CB Insights. If that proves to be correct, VC funding will have dropped by nearly two-thirds year-on-year, from $30bn in the second quarter of 2021 to just $11bn for the same period of this year.
This is not a “sector collapse” akin to the dot-com crash of the early 2000s, insists Rob Kniaz, partner at the London-based venture capital firm Hoxton Ventures. But it does mean that tech start-ups will find investment harder to come by in the near future.
“We’re seeing a certain form of belt-tightening globally in the tech world, where there’s not as much money coming in and valuations aren’t going to be as high as before,” says Kniaz. “For tech companies that want to go public, for example, the window for that is probably shut for another 12 months at least.”
This means that tech start-ups looking for investment will need to prove they can generate profit while keeping costs under control, Kniaz says. “VCs will now want companies to tighten their belts and want them to do more with less,” he explains. “So, in terms of capital deployed, you’ll see a downtick, but I think there will still be a high volume of deals done."
The end of convenience?
Some of the first casualties of this tightening of VC investment have been start-ups in the ‘quick commerce’ market. Last month, German on-demand grocery delivery service Gorillas laid off 300 staff after reportedly struggling to raise extra capital. This is despite having raised “close to $1bn” in October last year.
Kniaz says there has been “a lot of froth” in the market for start-ups offering consumer convenience at a price. Now, amid a global cost-of-living crisis, these companies are starting to look less attractive to investors.
“Costs are generally passed to the consumers… when companies tighten their belts,” he explains. “But if people are spending less, are they going to pay an extra 30% to have their food brought to the door?”
“For me, companies that require you to pay above the odds for convenience is probably not a strong place to be.”
But the issues facing consumer convenience start-ups do not apply to the start-up sector as a whole, Kniaz believes, which will continue to benefit from the ongoing digitisation of the economy.
“Over our lifetimes, I don’t think you’ll see yourself using less software either in your job or at home,” he says. “That’s why my general bet is always on new entrants with great software versus incumbents who aren’t good at applying technology to problems. The rest will sort itself out over time.”
As such, Kniaz remains fundamentally optimistic about the UK start-up sector in the long term. “From the perspective of the UK’s tech industry, those that survive this new environment will do well," he argues. "The advantage of the UK is that there is great talent here and the ability to scale globally is easier every single year."
“Europe and the UK specifically have a lot of the right raw materials in terms of experienced founders and the engineering talent to build really big, scalable companies.”
