How are VC and PE investors investing during a recession?

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Uncertain economic conditions create a constellation of issues and challenges for businesses, but the impact of such difficulties on venture capital (VC) and private equity (PE) investors is often overlooked.

Investment requires a degree of confidence, but turbulent economic and political conditions have made this even more difficult to achieve.

We explore how venture capital and private equity investors have been affected by the recent economic turmoil and how these investors are making investment decisions.

In this blog, we answer the following questions:

What is venture capital investment?
What is private equity investment?
How are investors responding to the current challenges?
Have specific sectors received more investment than others during this time?
How do investors decide on who to invest in during a recession?
How can you attract investors?
Why do the best investment returns come after a recession?

Every company launches with an idea but getting this idea off the launchpad is fraught with difficulties. That’s why funding is a crucial component of any new business idea. For many businesspeople, VC and PE investors provide the critical financial facility in the initial stages of growth.

However, generating investment interest has recently become increasingly challenging if the business has little or no commercial traction.

What is venture capital investment?

VC investment is a form of private equity that funds startups and early-stage emerging businesses with little to no operating history but significant potential for growth. It provides long-term funding for a share of the equity. It also offers access to technical support, a wide network of partners and experts, managerial expertise and experience.

Typically, VCs invest amounts from £50,000 up to £2m with an expectation of receiving 10x their initial investment.

What is private equity investment?

PE investment refers to a wide range of investment funds that invest in or acquire private companies. Typically, they invest in mature, high-risk businesses in more conventional industries, such as healthcare and software, in return for an equity stake in the company.

PE investors tend to invest £3m+ with an expectation they will recoup 3-4x the initial investment. They aim to increase the overall value of the investment and then crystallise their gains through a sale, flotation (IPO), merger, or recapitalisation.

However, although VC and PE investors are different, there can be some overlaps. For example, you can have early-stage VCs who invest in fledgling businesses and late-stage VCs who invest in more established businesses.

How are investors responding to the current challenges?

The coming months will continue to be a testing time for VC and PE investors as financial market conditions become more volatile, higher interest rates impact confidence and disposable income, and risk appetite begins to fall.

Smart investors aren’t waiting for more clarity; top-tier VC and PE investors are deep into planning mode to safeguard portfolio companies and futureproof the businesses from rising prices to account for the many risks associated with current market conditions.

Have specific sectors received more investment than others during this time?

According to a press release from KMPG, in the first quarter of 2022, the leading sectors for mid-market private equity activity are business services and technology, media, and telecom sectors dominated, accounting for over 60% of mid-market deals. The continued trend for remote working and digitally enabled services helped to consolidate this trend.

KPMG’s report also highlights the strong performance of healthcare and financial services, with the proportion of deal volumes growing in the first half of the year with 10% and 11%, respectively.

How do investors decide on who to invest in during a recession?

The good news is that investor appetite for growing UK companies, particularly tech-enabled UK businesses, continues.

Investors won’t stop wanting to make money. A recession may lead to the birth of more efficient companies. These lean businesses make investors hungry to invest in innovative technologies that have been developed in response to lower economic growth. For example, the innovation of the business services and technology and healthcare sectors have generated some of the strongest mid-market private equity activity, according to the report from KPMG.

As Environmental, Social, and Governance (ESG) become central to the corporate agenda, dealmakers will scout for deals that offer this angle. Due to their shortage, the multiples of these deals will likely rise significantly as they grapple with delivering on these environmental, social and governance commitments.

How can you attract investors?

A positive economic outlook brings an accessible pot of investor funds, but how can businesses attract investors during an economic downturn?

Under challenging conditions, cash is king. Businesses may need to cut frivolous expenditure and streamline their cash collection process to ensure they can continue to operate efficiently. This may consist of taking the focus off growth and sidelining new projects. Well-managed companies that have low debt, strong cash flow, and good balance sheets will be best placed to take advantage of available investment funds.

While a compelling vision, a market/product fit and a strong business plan can catch the eye of investors, robust accounting practices remain at the core of an investor’s requirements. If entrepreneurs can show increasing market share, strong cash flow and an upward revenue trend, these growth characteristics will make the business more attractive to investors.

In addition to the information and research outlined in this blog, the Enterprise Investment Scheme can also be used to encourage angel investors to invest by offering tax benefits. We’ve written extensively on the tax incentive here.

Why do the best investment returns come after a recession?

Recessions can create buying opportunities for investors who typically would have to pay a premium for high-quality assets under normal market conditions.

According to the latest mid-year private equity report by Bain Consulting, equity investors earn higher internal rates of return in years following recessions. In general, these investments during recovery years have “consistently outperformed the long-term averages, especially investments in top-quartile deals.”

Having amassed several decades of combined experience working with a range of tech-enabled businesses and an extensive network of investors, iFD has gained a unique insight into the fundraising options available to founders, particularly during challenging and uncertain times.

Please feel free to schedule a chat with this link if you think we can help.

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