“K-Shaped Recovery” Is The Way Forward For Start-Ups, VCs Say

As the world is still fighting COVID-19 and grappling with its effects on our lives, with the rollout of mass vaccination programmes it is time to ponder how economic recovery will unfold. What are the next few years going to look like for businesses?

A “K-shaped” recovery seems the most likely scenario: a two-tier response to the initial drop for most businesses will involve a significant rebound for some but a prolonged decline for others.

Different industries are going to have significantly dissimilar rates, degrees and phases of recovery. Companies in industries such as travel, hospitality and live entertainment will likely continue on a struggling path, while businesses bound for recovery and explosive growth are those that have proven resilient in the face of the pandemic.

As the past year has demonstrated, companies that have brilliantly weathered the storm are those that have provided solutions to the challenges we faced and will keep on facing – such as the need for remote and secure communications, data platforms and e-commerce.

In the VC market, the most successful companies will be those charging forward with remarkable growth.

Olav Ostin, managing partner at TempoCap writes on Crunchbase  that at the top of venture capital’s “K” will be businesses posting “at a minimum 50 percent revenue growth, but often much, much faster – and products typically built in the cloud, in many cases with recurring revenue models.”

Differently from the public market, the lower tier in the start-up ecosystem will still record growth, but at a significantly lower rate, ranging from 10 to 20 percent. Ostin believes that “for a business hovering around the 10 percent growth mark, it will take much longer to get to the big outcomes VCs are after.”

The consequence is that we will see historically high valuation multiples of 10 to 20 times revenue for the cloud-based and fast-growing businesses, compared to multiples of 1 to 5 for other companies, which combined form the K-shaped VC landscape.

These high valuations are the result of companies’ proven resilience in the face of the pandemic, as these businesses have not been disrupted and managed to continue running with minimal adjustments.

Moreover, customers switched en-masse to digital solutions (such as food-delivery and video communication platforms, among others), further increasing adoption rates for these technology firms.

However, some tech companies are having a harder time drawing investments. This is due to the fact that either their customer base or their supply chain is tightly linked to more traditional businesses, so their growth is lagging even though they have developed innovative technology. Examples of this could be e-ticketing businesses for events or tech suppliers for airlines.

In fact, according to The State of European Tech Survey, “access to capital” was the most cited challenge founders faced in 2020, followed by “pivoting the product”.

Nevertheless, the COVID-19 pandemic further accelerated digital change and made users even more reliant on tech.

The necessary shift to digital solutions greatly benefitted the tech industry overall, which saw a record-breaking capital invested to date, with over £30 billion raised by European tech companies, with UK-based firms accounting for over a quarter of all European VC investments.

In 2020, London raised almost half of all Europe’s FinTech capital and has seen VC investments grow threefold in five years, trailing only the city of Bengaluru, India, as fastest-growing tech hub worldwide.

Moreover, the pool of capital available is likely to keep on increasing, thanks to the growing number of American VCs investing in Europe. More than 550 U.S. institutions have participated in at least one investment round in Europe in 2020, an all-time high and up 36% in the past five years.

Funds such as Bessemer and Sequoia have set up shop in Europe, further pointing to an increased interest from overseas and a bigger pool of capital available for start-ups looking to raise funds in the near future.

Tech firms have thrived during the pandemic, offering disruptive services that are here to stay. They will be even more central and crucial to the economic recovery, but will their valuations hold?