Sunday, 15 January 2023

More shakeouts, down rounds and M&A for startups in 2023 — but investors are still bullish

More challenges to come for startups in 2023: Our year in review on StartupLand in 2022 recapped the biggest trends of the past year, with the most dominant themes (unsurprisingly) being the global VC squeeze, the ensuing high-profile downfall of Capiter and the waves of consolidation (and layoffs) across startups in various industries.

Many of these trends will carry through to 2023, as the global economy braces for more headwinds and a looming recession, and as VC investments continue to be viewed as a risky asset, our sources tell us. Startups going into 2023 will need to rethink their approach to growth, extend their runways, and look at alternative financing in order to come out stronger, investors say, and there’s a huge potential upside for those who play it right.

The VC squeeze is here to stay — but 2H 2023 could see some relief: Investors we spoke to agreed that the VC squeeze will continue to be a thorn in startups’ sides for most of 2023. Simon Tkachenko, partner at Modus Capital, expects the squeeze to see some relief in the second half of the year, as pressure amps up on VCs to deploy their capital.

Also here to stay: A weaker currency. A lot of startups have commitments that need to be paid in USD, like purchasing CRM systems or paying wages for foreign talent, said Aly El Shalakany, managing partner of Acasia Ventures, the VC arm of local investor outfit formerly known as Cairo Angels. The devalued EGP can also impact startups’ valuations, because most are expressed in USD terms but paid in EGP, which has made sharp FX fluctuations an issue in the past, Tkachenko said.

This will likely mean more flat and down rounds in the short term: “I think startups are going to have a hard time raising at an up round,” Tkachenko said, adding that the dominant narrative in the VC ecosystem now is that “a flat round is the new 3x multiple.” This is especially true in Egypt, where valuations since 2020 have been too high and at times “illogical,” El Shalakany told us. “The ones who raised at inflated prices last year are going to have to take down rounds and flat rounds, whereas those that raised at reasonable prices are less likely to have to do so,” he added.

That’s not necessarily a bad thing: “Ultimately, this will shake out a lot of bad companies, and a lot of good companies will be built and funded right at decent valuations,” Tkachenko explained. “The more sober environment we’re in means that companies that perform well will be able to find funding,” Algebra Ventures Managing Partner Tarek Asaad told us. “It doesn't have to be through mega rounds, but it will be enough to support companies through to the next milestone,” he added.

That’s a mixture of good and bad news: The less competitive environment is good for early-stage startups, especially when it comes to finding talent, Assad explained. However, companies hoping to raise their second and third rounds to survive are going to get tested, Karim Helal, executive chairman of Sequence Ventures, told us. Investors will be taking a closer and more critical look at startups’ expansion plans, asking how they plan to fund them, and if their plan is to fund them with their second or third rounds, that could be a concern, he added.

This could lead to more consolidations: “As funding is more limited, companies need to think of options,” Asaad said, adding that “there is a lot more potential for consolidation.” Tkachenko agrees, though he notes that the majority of acquisitions and cost-cutting is likely to have already happened in the past year. Global Ventures General Partner Noor Sweid has made the same prediction for the MENA region at a broader scale. “2023 will see increased M&A in the MENA region as a direct consequence of trends that permeated 2022, and which will intensify” this year, she wrote in an emailed note. “These trends are investors becoming more conservative, profit superseding the notion of growth at any cost, reduced liquidity and down rounds.”

And more startups prioritizing runway + steady growth: “Companies are focusing more on fundamentals; looking at runway and profitability,” Asaad said. Instead of layoffs, companies should now be focusing on improving their other metrics, including how to increase the lifetime value of their product for customers, Tkachenko said.

Many are also looking at expanding outside of Egypt as a way to hedge against risk: Expanding outside of Egypt diversifies startups’ operating financials and, potentially, their investor base, Asaad said. “I'm seeing several companies think of that as a sort of a hedge against some of the challenges in 2023,” he added.

And others are looking at diversifying their funding sources: More startups are in need of debt facilities to help plug working capital costs, Tkachenko said. Venture debt has a lot of potential in the region, he said, adding that he also could see new funding models take hold, like revenue-based financing, where investors provide startups with capital in return for a percentage of the company’s revenues. He also sees startups using crowdfunding as a method to fundraise, as well as venture building — which he says could thrive this year.

Those heeding this advice will find takers: Several investors we spoke to are still bullish on Egyptian startups. “I think the Egypt story will be even better” this year, El Shalakany said, adding that he expects to invest in around 16 startups out of one of Acasia’s funds — Fund I — this year, a big portion of which will be Egyptian startups. Asaad is also looking at fintech and agritech startups, while Tkachenko has named these two sectors and sustainability startups more generally, as some of the potential hot sectors for this year.

Your top stories on future trends for the week:

  • CheckMe buys Doctor Online: Healthtech startup CheckMe has acquired a majority stake in virtual clinic app Doctor Online in a transaction that gives CheckMe a total market value of USD 20 mn.
  • Fintech Galaxy acquires Underlie: Emirati fintech company Fintech Galaxy has acquired Egyptian API provider Underlie for an undisclosed sum.
  • Classera eyes expansion in Egypt: US-based MENA-focused e-learning startup Classera plans to up its investments in Egypt and add new learning and training services to its existing portfolio.
  • Enterprise sat down for separate interviews with Shaghalni’s founder and CEO Omar Khalifa and pharma platform Grinta’s co-founder Mohamed Azab.

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