As the world faces economic headwinds and geopolitical uncertainty, European founders must get used to making tough decisions to ensure the survival of their startups. This includes getting used to ‘flat’ or ‘downrounds’ funding, after the high valuations of recent years.
That was the message today at the Slush conference in Helsinki from Niklas Zennström, the iconic co-founder of Skype, CEO of Atomico and one of Europe’s most famous tech players.
In a keynote address, Zennström gave a blunt assessment of the economic climate as he unpacked how he failed several times in his own career during difficult economic conditions.
When talking about winding down two of his own businesses prior to Skype, he said today’s entrepreneurs should now focus their attention on the long-term success and survival of their businesses, rather than on the “good times of the bull market’. ‘ and the high valuations of the past, and that this would mean difficult choices.
Zennström said despite the bad reputation of downrounds (a financing in which a company sells shares of its capital stock at a price per share that is lower than the price per share for which it sold shares in a previous financing) or a flat round (a financing round in which a startup is issuing stock at the same post-money valuation as it did during the previous fundraising round, which basically means the value of the company has fallen), startup founders may have to accept these as the price they have to pay to keep their companies live for the longer term.
“There is a stigma. We have turned the down round into a worst case scenario. We’re ashamed of what it might say about our company, that it’s worth less now than it was a year ago,” he said.
He pointed to data from Pitchbook showing an uptick in downturns in the third quarter of this year, with nearly 19% of all European VC funding now meeting these criteria. This is an increase from 12% in the second quarter and the trend continues in the fourth quarter.
But he challenged Slush-goers to think differently about down rounds and not take it personally: “First off, ‘down rounds’ are just a function of the broader market. It’s the reality we’re dealing with right now. People are not willing to pay what they paid a year ago for shares in a technology company. Technology investment in the third quarter is about 30% lower than the same period in 2021. Series A pre-money valuations are down as much as 50% from their highs earlier this year. In this environment, a lower rating is not a reflection of you. It’s market dynamics.”
He added that startup founders who are currently raising money should raise money right away: “The main problem with down rounds is that people are leaving them so late. It’s easy to hope that the market will improve. I’ve seen founders tempted to delay the raise in anticipation of things changing. For a business that’s pre-profit, that means food on the future runway. And the fewer runways a company has, the riskier that company becomes.”
The 6-month alternative could mean “a rescue financing riddled with aggressive liquidation preferences and exit clauses. Don’t let that be you,” he said.
Finally, he said that down and flat rounds are “really about growth. Raising money strategically, before the point of no return, could be a masterstroke. Any founder who has the courage to raise money early, on decent terms, can continue to scale at a time when others are slowing down and losing talent. Now might be the best time to hire great people outside the competition. Whether the market changes within one or three years, these companies have not been sitting still.”
Reflecting on his own experience as a founder, Zennström said that prior to Skype he founded and bankrupted a number of companies, which was painful, but “in reality it wasn’t as big of a deal as I thought. My team had great experience and got great new jobs. And I took the best people to the next idea. The only thing that crashed was my dream… and maybe my ego. But once it was over, I was given the chance to start over. I was even more motivated to prove that I could build a successful business.”
He ended on a positive note: “I started Kazaa in 2000 and Skype a few years later – just after the stock crashed 80% due to the dotcom crisis. And at first I thought – wow, I missed the boat!… But then something crazy happened. We managed to find a way through. As our bank balance dwindled, we became sloppier and more cost-efficient. What I realized was that more resilient and sustainable companies come out of a recession. And based on what I saw then and what I am experiencing now, I have never been more excited about what Europe is building…”
After the speech I asked Zennström if he thought it selfish for a VC to have a glossy view of downrounds. He said: “Atomico hasn’t led many down rounds, so this is about my personal experience as an entrepreneur and situations I’ve seen talented founders struggle with years after Atomico’s initial investment. If there is a down round later on, we will be in the same boat as the founder – we both experience a possible drop in value.”
He said data does not suggest that this funding environment will go away any time soon, and that the current cohort of companies will experience more downturns: “The problem we have is that a combination of misplaced shyness and blind hope that the situation will change prevents founders from not raising it at all that means these founders stop building and technology stops being developed this could hold back some amazing technologies if we don’t kill the stigma that would be very wrong if europe has such a great toolkit for success in the long-term.”
Next month, Atomico will publish its annual State of European Tech 2022.