Between our two businesses (Rocking Horse group and Nighthawk Partners), the team sees an exceptional number of UK tech start-ups every month. In February, this meant talking to over 100 start-ups for the first time, and over 30 of those applying for a loan.
We also wrote over £2mm of new business - we could easily have done more by either lowering our credit standards (that will never happen) or if we hadn't been quite so capacity constrained on the Venture Debt side (we are working on this).
The key take away for February has been three significant trends in businesses who have applied for a loan:
Cost cuts to reduce the cash burn
Highly selective headcount reductions
Extension of cash runway by creative means
#1 Dealing with the cash burn
A significant percentage of businesses we work with have slammed the breaks on costs - the median being around -20% year on year cost cuts. Here's the chart for the businesses we saw in February:
Data based on 25 businesses (5 were stripped out as subsidiaries/shells cos/etc).
Increased revenues have also helped reduce some of the cash burn - our clients are, for the most part, still growing sales at a rapid rate. Has there been a link between cost cuts and sales growth? You decide.
Of course, what the data does not show is the quality of the businesses or the management team. It's fair to say that, on average, we have been more impressed with businesses that reacted quickly to the current environment and cut costs early.
#2 What's being cut?
Whilst we focus on tech businesses, we don't really have a specialty within tech. As a lender, we prefer having a broader range of diversified businesses in our portfolio than having all our eggs in one basket. We do not benefit from a sector doing particularly well, but we would get heavily penalised if a sector we focused on was suddenly hit by external factors. Thus, diversification is the key.
Our data therefore cannot be used to determine very specific trends such as seeing ad spending patterns at Google or Meta (we've been asked), but it does show that the brunt of the cost cuts have, across the board, been taken on staff. Even B2C companies that spend perhaps 30% of their revenues on advertising have cut staffing costs at least as much as ad spend.
The salaries cost cuts have been achieved through redundancies - it's not unusual to see business that have been through two or even three rounds of redundancies in the past six months.
#3 Plugging the gaps
Faced with significantly decreased VC appetite and/or significantly lower valuations, companies have also been fund raising in alternative ways. These are, roughly, the three main avenues we've seen businesses use to "plug the financing gap":
3.1 SAFE
Simple Agreements for Future Equity is an equity injection into a company where the strike price will be set at a later date. For companies with supportive venture capitalists who are founder friendly (and do not wish to mark down their investment) , this is an excellent solution for all involved. However, we've only seen businesses which have a credible plan to be at least EBITDA flat by the end of this year receive SAFE investments.
3.2 Convertibles
Convertibles are more common as the new investment becomes senior to the existing equity holder. This is, literally, an option on the business by the new equity investors. Founders should however be careful on the exact terms of the convertibles so as not to jeopardise their ability to take on other debt funding.
Convertibles also allow the business to avoid a down-round, however a strike price on the convertible that is at or below the previous fund raise will have the same effect as a down-round.
3.3 Debt
We've seen a very significant increase in demand for our services in the few months. That is of course a result of our marketing department being pretty good at their job, but it also reflects a wider desire to avoid dilution at what is probably a low point in the tech market.
Here are the criteria we look at for businesses wishing to raise cash:
- Is the business able to repay us from cash flows?
Revenues are key here and can include:
income from signed contracts,
recurring revenues,
grants and R&D Tax Credit
future equity raise – actually scratch that one
As long as it is legally binding, we will see if we can finance it.
- Are the sales forecast realistic?
98.7%* of forecasts we receive are "hockey stick". That's fine if you're talking to equity investors, but for debt investors, anything that doesn't fall under the admissible revenues above will likely be zeroed out.
* Not a real statistic
- What other creditors are there?
We will usually look to be the senior-most creditor on any loan we make, including a fixed and floating charge on the asset of the business. We've turned down business where the founders had given such charges to a high street bank for a £30k credit card limit. So be careful what you agree to when dealing with lenders as other lenders will take that into account.
Conclusion
The businesses we're most likely to lend to are those that have already adjusted for the current environment. If you haven't cut costs yet and you're not EBITDA positive, what are you waiting for?
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