By Simon Brendel

 

2023 was a tough year for the venture and tech scene – in many ways even tougher than the previous one. However, for us, this year was also full of exciting tech assessment projects: We saw our Deep Tech and especially AI project volume grow continuously – sometimes with sophisticated hardware components. We supported complex industry M&A transactions and Private Equity investments. And we continued to work with Venture Capitalists (VC) and founders, building up exciting tech companies. We want to reflect on trends we saw in our work in 2023 and what conclusions and expectations we can draw from them for 2024.

 

2023 – The Year of Regression to the Mean

The tech and VC ecosystem has faced significant challenges this year: Rising interest rates, a bad economic outlook, and other external factors have led to a decline in funding of nearly 45% vs 2022 in Europe alone. The European VC market is back to the pre-pandemic growth rates, with roughly 20% more funding than in 2020.

The decline in VC funding has had a notable impact on the availability of capital for many startups. Most investors turned to their internal portfolio first, to provide them with bridge rounds to continue operations. The amount of bridge rounds was up 10-15% vs 2022 in absolute numbers across all stages of the company lifecycle.

However, despite the difficulties faced, the European tech ecosystem has shown resilience and adaptability: Europe was the only region that grew its investment amount compared to 2020. We believe that this this year was kind of a regression to the mean and we will see sustained growth over the next years based on certain factors:

The Rise of Deep Tech

One of the big trends that resisted the overall market sentiment is Deep Tech investing. The total funding in European Deep Tech companies has even increased by 2B $ according to the State of the European Tech Report.

Given the current geopolitical, climate, and other challenges on a macro level, VCs are increasingly recognizing the immense value that companies can create. Despite the higher technical risk and capital requirements associated with these companies, the market opportunity is strong enough to justify taking on such risks. VCs are becoming more willing to invest in these ventures, understanding the potential rewards they can yield. After all, because of their strong technological edge, Deep Tech startups have a higher defensibility against competitors. Additionally, strategic investors are increasingly realizing that they can pursue investments with innovative companies and Deep Tech startups to pursue their innovation demands.

In projects like the 100M$ Investment in CMBlu by Strabag or the investments by Ananda in NatureMetrics in 2022, we have worked with truly innovative companies. With Deep Tech on the rise, the importance of Tech Due Diligence grows, as these companies usually have more complex tech stacks. A good Tech Due Diligence supports Deep Tech founders in building the best products.

For 2024, we expect Deep Tech funding to continue to stay on its growth path. However, implications of regulation need to be anticipated, especially in Artificial Intelligence, as new frameworks are emerging such as the AI Act in the EU and the AI Code of Conduct between EU and US. Safety issues surrounding bias, accuracy, reliability, and model performance will continue to need attention, as well as security concerns surrounding model and data stealing, data poisoning, and evade detection.

At the same time, we believe we will continue to see more specific Deep Tech use cases come through in 2024. Something we have already seen happening this year, in healthcare diagnosis and treatment optimization, in manufacturing, and in addressing environmental challenges, from energy to biodiversity.

AI- and Data-Driven Manufacturing and Construction

We are seeing Construction transforming. Sophisticated, low-maintenance solutions are coming to the fore, to give manufacturers a real-time view of their operations. We saw this reflected in some of our projects this year.

For example, Berlin-based ecoworks recently raised a €40 million funding round. They have developed an ultra-efficient building skin for real estate, supported by an AI-powered digital planning solution, that reduces the climate impact of the built environment. Other examples would be the French Prop Tech Company Vizcab, which developed a platform specializing in data-driven solutions for Life Cycle Assessment (LCA) in construction projects. Or Berlin-based Spread AI, which builds a data-layer on top of the hardware engineering lifecycle.

We believe we will see more of these kinds of deals happening shortly, as Manufacturing and Construction are under pressure to cut costs, improve sustainability, and speed up supply chains.

Digital Health Powered By Data

While Healthcare is taking longer to digitize than many other sectors, due to its complexity, structural, and regulatory challenges, we have seen several startups innovating in this area, oftentimes with AI and sophisticated hardware approaches.

Take Swedish Healthtech company Neko Health, for instance, which raised a €60m Series A round led by Lakestar earlier this year. Neko works on creating a healthcare system that can help people stay healthy through preventive measures and early detection, incorporating the latest advances in sensors and AI. In our Tech Due Diligence, we assessed the company’s AI approach in combination with hardware components in sensors and medical scanning technology, which is being used for broad and non-invasive health data collection.

Another example is Floy, a Healthtech startup from Munich we assessed on behalf of HV Capital. They are developing AI to support radiologists in seeing diseases difficult to detect. Or Qualifyze, a Frankfurt-based Startup offering data-driven supply chain compliance solutions for the pharmaceutical industry.

Challenges in Healthtech remain around tech implementation and cost savings, integration, and data, given data privacy regulations such as GDPR. As these challenges continue, we expect to see a whole host of technology companies like the above-mentioned emerge and revolutionize Healthcare, including therapeutics software, AI, and predictive analytics to support early intervention and provide diagnostic and treatment solutions.

More M&A in Tech

While the M&A market was slower this year than many expected, we have worked on a couple of M&A deals this year, including EdTech Company Sdui’s acquisition of Additio App, the merger of Habyt and Common, and most recently, HomeToGo acquiring majority stakes in kurz-mal-weg.de and Kurzurlaub.de.

Looking at the broader market, while many companies successfully managed to sustain themselves through debt and bridge rounds funded by their internal investors over the past year, it is important to note that these rounds alone may not be sufficient in the long run. Eventually, these companies will need to seek new external capital to support their growth. Therefore, in 2024, many of these companies will find themselves in a position where they have to venture into the market once again and engage in fundraising activities.

Given the prevailing market pressures and the potential closure of the IPO window, we can anticipate a significant surge in mergers and acquisitions (M&A) from two different perspectives:

1.) Strategic investors, as mentioned earlier, may opt to pursue majority takeovers when they believe that a particular technology has been validated and is robust enough to offer a promising product outlook.

2.) Strong companies will proactively embark on a path of industry consolidation, seeking to acquire competitors to expand their market share and/or diversify their product range. This approach will enable them to strengthen their position in the market and capitalize on new growth opportunities.

The Trend Towards Data-Driven Investing

Data-driven Venture Capital investing is becoming increasingly important as in more competitive fundraising markets, investors are seeking ways to mitigate risks and make more informed investment decisions. By leveraging data and analytics, VC firms can gain valuable insights into market trends, customer behavior, and the performance of potential investment targets. This data-driven approach helps investors identify high-potential startups, assess their growth prospects, and make strategic investment decisions.

Advancements in Artificial Intelligence have revolutionized the investment landscape. AI-powered algorithms can analyze vast amounts of data and identify patterns and correlations that humans may overlook. This enables VC firms to uncover investment opportunities with higher precision and efficiency. Data-driven investing also allows for more accurate monitoring and evaluation of portfolio companies, helping investors identify areas of improvement and make data-backed decisions to drive their success.

While we continue to grow our data-driven assessment, we have been in an increasing amount of conversations with many investors on how to build and leverage their data in the best way possible. As the European tech ecosystem continues to evolve, data-driven approaches will play a crucial role in shaping investment strategies and driving the success of startups in the coming years.

Conclusion

In 2023, we continued to see a strong shift towards leaner teams aiming for profitability. Although this is a challenging pathway, the reality adjustment within engineering comes with a healthy pragmatism and a stronger focus on markets, customers, and products. A development that we welcome, because it shapes a stronger and more resilient startup ecosystem. This is something we expect to continue in 2024.

Slow growth and global instability will probably remain for some time as well. This will continue to impact valuations and investor confidence. A lot of companies that haven’t raised this year will have to raise in 2024. That will bring a lot of repricing, along with some write-offs in VC.

But the European tech ecosystem is poised for further growth and evolution. Several trends are likely to shape the landscape in the coming years. We are looking forward to many great discussions about more technical projects and investing.

 

Why the Funding Climate is Driving Mergers and Acquisitions in Tech

The slowdown in funding is making it incredibly difficult for startups to raise money. As a result, more mergers and acquisitions (M&A) will take place in the near future. Many founders will look for an exit by looking for a buyer, as they may not have any other options to avoid going bankrupt. At the same time, lower valuations make M&A more appealing for financial and strategic investors who want to enhance their portfolio or grow their business without spending too much money.

Macros Point Towards More M&A in Tech

Many companies raised two to four years of runway in 2021. As their runway is coming to an end now, they find themselves in a very different market environment. Since the beginning of 2022, European tech companies in both public and private markets have experienced a loss of around 400 €B in value according to the recent State of European Tech Report by dealroom.co, based on data by S&P Global. This caused the total ecosystem value to drop from its 2021 peak of 3.1€T to 2.7 €T.

Unsurprisingly, in 2022 VC deal value YoY also dropped for the first time in the past decade according to data from PitchBook. European VC deal value decreased by 16% last year while fundraising stayed mostly on par with 2021 – suggesting VCs sit on a lot of dry powder for the time being. In fact, the European VC ecosystem is expected to have a record amount of 60 €B in dry powder in 2023.

Despite record volumes of dry powder, VCs are less willing to take risks. Instead of investing in new companies, they are providing bridge financing to their existing portfolio companies. This results in less funding being available in the market, especially for startups beyond their Series A stage. This funding decrease is particularly noticeable for companies that are not demonstrating strong commercial numbers and traction.

The reality of the new market environment is reflected in the study State of European Tech, in which 82% of founder respondents believe it is now harder to raise venture capital than it was 12 months ago. VCs share this impression, by stating that the change in the market environment has impacted fundraising dynamics for their portfolio companies. Overall, fundraising takes longer and there are more bridge or extension rounds as well as slower decisions by investors. In addition, exit processes are delayed and investors demand more extensive and deeper due diligence.

PE deal value remained rather resilient according to data from Pitchbook, although European PE exit value reaching a nine-year low in 2022 as is down approximately 13%. Megadeals also hit a nine-year low, but there were more smaller deals. For 2023, analysts expect the value of take-private deals to reach 30 €B, with fewer than 40 PE-backed public listings to take place.

Overall, European M&A remained quite robust: We saw a record number of 17,900 deals, a YoY increase of 11.7% from an already record-breaking year. Although the value of European M&A deals declined, this indicates that there were more deals with slightly lower values compared to 2021, as mentioned above.

 

As the conditions remain very much the same and for some tech companies even turning more dire, we expect to see even more M&A activity in 2023. At the same time, companies that are in a position to acquire other companies are taking advantage of lower valuations, which allows them to acquire high-quality technology, strategic partners, or talented people at a more reasonable price. Therefore, we predict that 2023 will be a year of tech startup M&A, potentially including Series A and even some seed companies.

Different Tech M&A Scenarios and How Tech DD Supports Them

Financial M&A

First, there is the financial M&A scenario, in which a company is acquired by financial investors, particularly Private Equity players. The lower valuation in the market is a major driving force for financial investors to increase their funding and acquire companies at a reasonable price, thereby improving their risk-return profile. For them, it is critical to verify the product’s capability and evaluate any technical risk that may impact their growth plans. For this financial investors should rely on a deep tech due diligence.

Buy and Build

Then there are the buy-and-build cases. With the help of a Tech DD, these investors want to understand the integration capabilities of the company they plan to acquire. If the company is a platform, they want to understand if they can add other components to increase its capabilities. If it’s an add-on to a platform, they want to understand how the technology of the company they plan to acquire integrates with that platform and if the integration is feasible based on the PMI schedule and the potential technical outcome. Integration risk is usually highly underestimated by many Private Equity investors, as it can make or break platform acquisitions.

Strategic Acquisitions

Strategic M&A is all about acquiring companies that align with the long-term goals and objectives of the buyer company. The focus lies with the potential of the company, such as the team, technology stack, or product. This can be seen in both scale-ups acquiring competitors and corporates acquiring startups.
The idea is to increase existing capabilities and leverage the strategic potential of the acquisition. Throughout the acquisition process, it’s important to evaluate the potential synergies and benefits by conducting a Tech DD. This includes things like product complementarities, technology integration, and market fit.

Product or Technology Acquisition

Product or technology acquisition is another type of strategic M&A. This happens when a buyer sees potential in the product or technology of another company and wants to add it to their existing product line. The aim is to enhance their offering and increase market share. Through a Tech DD, acquiring companies want to understand and evaluate the technical feasibility of the product or technology, understanding its limitations and future roadmap, and assessing the risk of integration with their existing systems and processes.

The technical team of the buyer company will typically be involved in evaluating it to ensure it’s a good fit. It’s crucial for the acquiring company to understand the technical capabilities of the individuals they plan to get on board to make sure the integration goes smoothly and meets their innovation goals. Evaluating the technology and product being developed by the target company can also help the buyer assess the potential future impact of these individuals. To make sure the integration is successful, it’s essential to get a clear understanding of the capabilities and skills of the individuals in the target company, as well as their track record of achieving their technical goals. The buyer also needs to consider how well they fit with their vision and objectives.

M&A for Integrity of the Tech Value Chain

It’s important to consider the health of the startups that play a vital role in your tech value chain. Without fully understanding the potential impact of a startup’s failure or disappearance, companies risk facing significant disruptions in their operations. For instance, many tech firms rely on startups for payment infrastructure, but often overlook the risk of a startup going bankrupt. In such cases, the impact on a company’s operations could be severe.

To avoid these risks, some companies choose to acquire critical startups and take control of their products. However, to do this successfully, companies need to carefully evaluate the technical risks and reliability of the product with help of a Tech DD, and then plan for a smooth transition to in-house operation. It’s also important to have a well-structured plan for post-merger integration (PMI), including retaining key team members and ensuring a seamless transition to the new operation.

AI Companies Pursuing M&A for Proprietary Data

Another scenario, that we will see much more in the tech scene, has to do with the recent rise of strong AI business cases. This M&A type can be considered a combination of both the strategic integration and the functional aspect of the tech value chain. Here, companies are acquiring other companies, even those from traditional industries, for their data.

In the AI industry, many companies are building their own machine learning models and intellectual property. The differentiating factor between these models is the data used for training. To enhance their models and achieve a competitive edge, many companies are seeking to acquire data providers or companies that have been collecting data for a while.

In this scenario, the main focus of the Tech DD would be to comprehend the data collection methods, validate the data’s continuous availability, and assess the diversity and integrity of the data set. In some traditional industries, the data’s labeling and diversity may not be ideal for machine learning, requiring substantial effort to clean and label the data. If the data set lacks diversity, the investment’s return will not be favorable. So, it’s crucial to evaluate the data collection process, its sustainability, and the diversity and quality of the data set.

Have Technical PMI on Your Radar

Currently, there is a lot of emphasis on cultural aspects and general PMI, but neglecting the technical PMI may lead to the failure of the acquisition. That’s why it is essential to execute the technical PMI correctly. This aspect is often underestimated, but it’s crucial to the success of the M&A case. If the integration of the technology stack is poorly planned or has incorrect goals, it can result in failure, dissatisfied customers, and negatively impact business performance. That’s why it’s essential to prioritize technical PMI during integration planning for tech companies.

Conclusion

Tough times will in part become a test of strategy for companies, and also of character for founders and tech leaders. During these periods of pain it is important to keep in mind that pain is temporary. Tech remains strong in Europe, despite the current setback. It will continue to be a massive wave of transformation, with many future opportunities yet to come. At the same time, tech companies need to face and adjust to the realities of the current market and find the best solution at hand. For financial and strategic investors, this can be a time of opportunity. But the technical risk of any M&A case should be effectively bridged with solid due diligence and the technical integration carefully planned and properly executed.

Bringing Together Friends From Startups and Venture Capital

Before the summer is officially over, we wanted to take the chance to party with old and new friends from the Startup and Venture Capital scene. Together with our partners from Torq.Partners, Cremanski & Company, Moss, Sastrify, and Thryve, Philipps & Byrne came up with Berlin Vice – a summer closing boat party which was all about minimum business talk and maximum fun and party.

On September 8th, VCs, founders, and executives from tech tech startups came together to have a good time and experience Berlin by night on waterways. We created an event for everyone to celebrate, exchange, and network with their peers. Many embraced our motto Berlin Vice – in good old Miami Vice tradition – and got creative with our (voluntary) dress code. From magicians to DJs – we all enjoyed the entertainment on board, the flying buffet, and the open bar.

And while it was mostly fun and games, Berlin Vice showed us once again how closely intertwined the VC and the Startup scene is. Socializing and fruitful exchange is so important – on every level. This is something we see in our everyday work as well. Our findings oftentimes are something of a conversation starter, facilitating honest discussions about sometimes uncomfortable truths between VCs and founders.

We totally believe that meeting on an authentic human level helps to build real trust and allows people to have these important conversations. We want to create a platform for exactly that, whether it’s at a tech due diligence, a health check or on a boat tour.

 

  Revisiting the Combined Chief Technology Officer and Chief Product Officer
  By Chris Philipps, Founder at Philipps & Byrne and CTO of 10 Years

 

Last year there was a lot of talk in the startup scene about having a CTPO: Meaning a CTO (Chief Technology Officer) and a CPO (Chief Product Officer) unified in one person. To be honest, this really is not entirely new – this kind of unified role has always existed before in the startup scene and everywhere else as well. However, for a specific time something happened that I would call a trend. Why? Because everybody was talking about the CTPO thinking it is a great new idea. It was a little bit like what happened with Agile or the Spotify model. Neither of those were entirely new ideas, and they were based on certain principles that already existed. But people quickly adopted what were perceived as novel approaches, without reflecting on them deeply. And I think that is a mistake! While the debate has kind of blown over a little, the question whether to have a CTPO or separate CTO and CPO roles is still very relevant for young companies building their organizational setup. It is something that we continue to encounter on a regular basis. That is why I would like to revisit the topic and comment a bit on this CTPO model.

Like Being In a Good Marriage

While I think in some setups and at certain stages this unified function of a CTPO can make total sense, I think it is a bit risky in other contexts or with certain people. Product and tech, although being closely related to each other, usually have very different angles on how they perceive the world in general and the business in particular.

Product management people are usually very business and user oriented. In their position, it is more about the Why. Tech people on the other hand are traditionally more focused on the How. Certainly, that has changed over the last twenty years or so, and we can see the roles having become closer to one another. But still: The emphasis on the business, the capabilities of calculating a business case and thinking strategically in terms of business and product strategy; that is still something product people are usually much better at than tech leaders.

The reason why people at early-stage startups want to combine the CTO and the CPO into a joint CTPO role is, first of all, the (false) hope for a reduced budget. Unfortunately, in most of the cases, this is an illusion because any candidate who really lives up to the expectation is usually very expensive.

The second reason is that you naturally want to bridge the gap between the tech and the product organization – and that makes total sense. After all, you want to have the two as closely together as possible. So there is the expectation that if you have one person leading both tech and product management, that they will be uniting those two teams, and you will not have that gap. However, I think that is a little bit of an illusion as well. Almost every person that I know in one of those roles has a certain preference, a certain background, and level of expertise. Usually, you are either best at one or the other.

Oftentimes when a person who is technically very strong takes over that CTPO role, they have a certain bias towards technical decisions. That can be unconsciously, which makes it even more dangerous. This holds true the other way around as well: If you have someone who is very strong at product, but maybe tech is their weak spot, the decisions they make are oftentimes more in favor of product and business and sometimes tech does suffer.

So revisiting this topic, I personally am still very much a fan of having two people in those two roles. In a well-working setup, it is like being in a good marriage. You are fighting here and there, and you do not always have aligned interests, but you figure out a way. It is a constructive fight that you are having – more like wrestling. And in the end it is a joint effort, and you achieve a shared goal. So, if you have one CTO and one CPO then you always have a sparring partner whether you want it or not – again, like in a marriage. And they remind you of something you tend to forget.

Before You Know it, Complexities Can Become Overwhelming 

If you have a very early stage company with a small team size and a very narrow focus to look at, and you are currently in the process of building a prototype and MVP, a very early first version – fine, have a CTPO model. No problem at all. You will be able to handle the context, team, technology, product and everything else at once. But as the company grows, the complexity grows as well. Naturally, you will have to deal with a bigger product and technology scope as well as team size. And of course, you also need to take care of the market: Do you have a good product-market fit? Do you have the right business and product strategy? And how do they align with one another?

Suddenly you will be dealing with a lot of topics, which can quickly become overwhelming. To be honest, most CTOs and CPOs that I know are not entirely capable of handling all of that or even overseeing it by delegating it to the right people. Usually they are pretty good at what they are doing, but they are also challenged with the daily issues, topics, and requirements you have in a fast-growing startup.

So in the first phase of a startup or if you are a scale up that is well established, and you have the budget to hire a top-notch CTPO or someone with plenty of experience, seniority, and strategic knowledge, then the joint role can make sense. Go for it! But in the phase in between, I am not sure about whether this is the best solution. So I would say take a closer look at your organization and the requirements. Look at the potential candidates for those separate roles or such a unified role. I would like to remind every CTO and CPO to really do some soul-searching whether this is the next step of development. Can you already master a CTPO role easily, or would you like to focus a little bit more on improving your skills in your core domain or expertise before you make that next step – because it will be a lot!

Find Out What Works For You!

So is the CTPO role right for you – or separate CTO and CPO roles? In the end, as always in life, it depends. Of course, there are people and setups where a CTPO model works best. This is the ideal. But let’s face it: Many people in Tech and Product leadership positions are already challenged with one of those roles. Both are demanding positions which require lots of skills. The war for talent is already incredibly tough, even if you just look for either a decent CTO or a capable CPO.

At the end of the day, you have to be honest. The CTPO role is not for everyone. If you find one of those gems who are equally capable of both Product and Tech, and it works for your setup, consider yourself extremely lucky. Gems are rare for a reason. But do not necessarily think that this has to be the way and blindly follow that trend. Because in many cases a team – and it is a team sport after all – of CPO and CTO works much better than an overwhelmed or even biased CTPO.

Takeaways from a Tech Panel at FutureWorldVC in London
By Chris Philipps, Managing Partner at Philipps & Byrne

 

Did you ever ask yourself: Are we doing the right kind of technology and product due diligence on our startups? Many Venture Capitalists are confronted with this question, and the main reason for that is that there really aren’t any clearly defined standards for tech due diligence. What we see  in reality is that TechDD is often based on self-developed procedures, trials and errors, and a somewhat common understanding of best practices. The result of this is that tech due diligence can mean anything from a 30-min call with a CTO from another portfolio company to a 14-day in-depth analysis with industry experts and technicians. So, there clearly is a need among VCs and their target companies to get clarity on whether they are doing the right kind of tech due diligence.

FutureWorldVC: Investors, CTOs, and Tech Advisors Have A lot to Talk About

Zoe Peden, Principal at Ananda Impact Ventures, tapped exactly into this need when inviting the FutureWorldVC community to a panel discussion in London. I was happy to join the panel with Perran Pengelly, CTO and co-founder of DrDoctor and Sara Stephens, CTO and co-founder of Rest Less. It was a perfect setup of VCs, founding CTOs, and technology advisors coming together to exchange ideas and experiences.

On my part, I talked about our approach to TechDD at Philipps & Byrne: What are the objectives, timelines, and deliverables of such a tech assessment? I went into how we work with VCs and startups, and what both sides can and should expect from a proper tech due diligence based on best practices. We also shared some -anonymized- examples of typical red flags or positive impressions. Perran spoke about his experience of working with us and provided some honest reflection of the challenges and positives that came out of the experience. Sara brought in her experience from two TechDDs performed by other service providers and shared super insightful feedback she had gathered from surveying members of the CTO community. These numbers were a great basis for the further discussion among us and with the audience.

Takeaways: What We learned at FutureWorldVC

Despite being a speaker at this event, the exchange with the different participants gave me plenty of fresh input and insights. Also, let’s be honest here: I have been exercising tech due diligence for ten years, and yet we are still trying things out and are keen on finding a better approach for everyone being involved. So for us this was a perfect learning opportunity. Here are some of the things I learned during the conversations with VCs and tech leaders in London:

Investors want clear(er) guidance from Tech experts

Understanding what is going on is of the essence for investors – especially if they do not come from a tech background. Many of the investors – but also the founders – shared their experience of getting a 2-pager TechDD “report” without a clear indication of whether to invest or what to do after the investment.

What they actually want is clear advice on action items, dos and don’ts, next steps, and priorities for both themselves and their target company. There is definitely also a desire for clear benchmarking, rating, and comparability with other investments. In general, investors want tech assessment to be derived from the business context, and how that context translates into tech solutions, set-ups, and processes should be an essential part of the TechDD.

TechDD Findings can be a Conversation Starter for Delicate Topics

One aspect we brought up during the discussion is that the results of a tech due diligence can serve as a well-founded basis to address difficult tech topics on board level. I know from attending board meetings myself, that often slow time to market is being discussed with or without naming Tech issues as a root cause. Having tech assessed by an external expert and going through issues in a structured way is always better than discussing on the basis of a gut feeling or a hunch. Having a structured and honest discussion in the DD phase contributes to more fruitful board meetings with shared expectations clearly set.

Founders and CTOs: Transparency is a Real Game Changer

One of the most interesting findings was brought forward by Sara, who did a survey on two CTO networks. She found out that two-third of founders feel stressed during a technology and product due diligence. But even more important: Apparently there is a direct correlation between stress levels and the degree of transparency regarding the assessment process. In other words: The more transparency, the less stress. As simple as it sounds, the data was impressive:

• Where there was NO transparency on the process, 100% of people were stressed
• With a little transparency, 60% of people were stressed
• With enough transparency, 45% of people were stressed

This begins with having clarity on the deliverables and continues during the assessment itself, all the way to the report. Transparency throughout the entire process makes a real difference.

Secondly, the mode of operation is very important. Here we can see, the more the due diligence is done in a sparring mode, the better. The less this is done, the more useless the experience is conceived by founders and CTOs. Among the CTOs she surveyed, Sara found out that half of respondents felt a TechDD was useful for both investors and founders/CTOs, and half of them felt it was not. This indicates misalignment and inconsistency around the TechDD process and outcomes.

Thirdly, Sara’s survey also found that 80% of TechDD conducted focused on the technology being used in the target company at some point in the process, but only 50% of the tech leaders felt that was actually important. This is an interesting indicator for the business context, often not being considered enough during a TechDD. Meaning, those conducting the assessment are not applying a true 360 degree approach. This channels back to the investors’ desire of tech assessment being derived from the business context.

And finally, and this cannot be overestimated, if the TechDD and the following report provide concrete and actionable guidance for the future, it can function as a long-lasting leverage for tech in discussions with non-tech founders and investors. Perran mentioned in this context that  almost two years later, the engineering leaders in his company still bring up the findings from the TechDD as a gentle reminder for keeping certain standards up. This is what true value derived from a best practice tech due diligence looks like.

Wrap-up: Whether You Do TechDD Right or Not Makes a Huge Difference

So, what can we say about the FutureWorldVC panel wrapping up? First of all, it was a blast! Second, these kinds of dedicated spaces to exchange, learn, and get inspired are so beneficial and valuable, also for us. So many thanks to our client Zoe for putting the whole thing together, as well as to the two post-series-A Tech startup founders, Perran and Sara, and all the participants who so actively contributed to the discussion.

Coming back to the initial question: Are we doing the right kind of tech due diligence? What we see is that whether a tech due diligence is done right or wrong has a great impact on all parties involved. If done wrong, investors lack understanding and visibility, founders and CTOs suffer from enormous stress due to intransparency, and tech advisors have a hard time accessing information and gaining insight, due to a possibly hostile environment. But if done right, meaning with a clearly pre-defined and transparent process according to best practices, TechDD can be the most thorough, honest, and valuable external feedback investors, founders, and CTOs can get. It can provide beneficial findings and actionable recommendations that can help support tech and product strategy and future growth. And last but not least, it can be an important conversation starter between investors and founders about uncomfortable truths that will appear on the board level anyways at some point in time.

Interview with Simon Brendel, Philipps & Byrne

As the first half of the year lies behind us, we in the Venture Capital and Startup world find ourselves in a very different place than 12 months ago. From your perspective, what is happening right now?

Simon: We are definitely seeing a slowdown in investment activities, especially in the growth segments (series B onwards). There are a couple of reasons for that: First, 2021 was a record year in venture capital. A remarkable amount of deals and funding happened with much higher valuations than previous years. Inevitably there had to be some sort of slowdown sooner or later. So in this sense, I’d rather call it a correction, as opposed to a market collapse or anything like that. And that can actually be quite healthy.

Second, money is no longer cheap. Interest rates are slowly rising, which of course has enormous implication on funding on one hand, and where people allocate their investment on the other. In times of zero interest, there were not many investment options that promised yield, so it was logical that more investment went into venture capital. As more investment options are yielding interest again, less money will move into venture. However, keep in mind that there is still quite a lot of dry powder around that is somehow committed.

And thirdly, uncertainty around inflation and the underwhelming stock market performance of some startups and scaleups that recently went public, has caused some nervousness. Especially among those investors who see companies they are engaged in going public in the near future. After all, we have seen some companies that reached high valuation before going public, but afterwards haven’t necessarily fulfilled expectations at the stock market. This is channeling back into the pre-IPO phase. Investors are rethinking where valuations should be during funding rounds, as they might not actually see the anticipated returns, once these companies go public. And if that proves to be right, people are going to shift that capital to other investments that can generate higher returns.

What implications are these overall market corrections having on VCs and startups?

Simon: Well, we are definitely seeing VCs pushing their portfolio companies from hyper growth to profitability. That means cost reduction, first and foremost, but also reassessing and restructuring organizations in light of the current market climate. Basically, VCs and founders are asking themselves: What are the implications of inflation and higher capital cost, investment reorientation and reallocation, and fluctuating demand? How does this change priorities and roadmaps? Uncertainty drives desire towards investments that can produce near-term certainty and profitability, and this is a proof startups need to deliver now. This will be a decisive factor, for new funding rounds or in securing bridge funding from current VCs.

Is the investment cool-down noticeable across all funding stages, or are certain stages more affected than others?

Simon: The ability to raise funds for startups does depend very much on the stage right now. The stock market climate impacts later stage companies much more, and they are currently struggling to get deals done because investors are skeptical about the exit prospects. Right now, investors don’t really want to pour money into a company that plans going public in one or two years. For seed and early stage startups, IPO is still far on the horizon.

However, early stage startups are starting to reassess their funding goals and valuation expectations in light of the general market cool-down. They, too, realize that those hyper valuations of 2021 might not be realistic anymore. And overall, closing funding rounds is taking longer and there is more risk analysis and due diligence from the venture side again. Which, again, is actually a good development and very healthy.

So you expect risk evaluation and due diligence will play a more important role again during funding rounds

Simon: Yes, very much. In the recent past, we have seen VCs completely skip due diligence to get deals done quickly. In some cases, this might have contributed to the underperformance we are seeing now. And as the market is less favorable in general, more uncertainty and higher capital cost, of course risk management and due diligence are and should be top priorities for smart and sustainable investment decisions. And as we are in an ongoing digital transformation of entire societies and economies, technology will play a crucial role in all of this.

In which way?

Simon: Technology and product management are extremely important in any startup today. The way teams work with tech, how processes are designed and how well they are automated, the degree of maturity of product roadmaps and their development can make or break a young business. Also, how well business decisions and strategy are based on metrics and data, simply matters, if you want to secure future funding or convince your current VC to provide bridge funding. For this, you need data intelligence and technology.

What should VCs and Startups do now with regard to tech when working towards profitability?

Simon: As technology plays a crucial role in the capability of startups to shift from pure VC backed growth to profitability, we currently advise all our clients – on the investor but also the founder and startup side – to do a thorough check-up on their technology and product set-up to get a realistic understanding of how resilient and capable their tech leaders, teams, processes, and architectures are, and how well they manage the transformation towards profitability.

A lot of startups that are venture backed already will now have to have a frank conversation with their board on the perspectives of fundraising and in many cases, bridge financing will play a role. Doing their homework on the tech side, can be a decisive factor. However, to prove this, VCs might want to see an expert tech advisory report rather than just taking your word for it. But given this, they likely will be open to provide capital you need to get through the rest of the year.

What do you expect to happen in the Startup ecosystem moving forward?

Simon: We could actually see things get worse before they get better. There is still somewhat of an overhang from 2021 spilling into this year: Deals that have been done under a high valuation in late 2021 that have been announced recently or are still to be made public. As these run out, we could see the next quarters perform even worse.

Definitely, we will see the overall market correction settle in, which will most likely go hand in hand with some layoffs at strong growth startups. And we expect much more consolidation and M&A activity between startups as well as private equity and startups. Also in this context, risk analysis and due diligence will be key for making the right business decisions.

And beyond 2022 – well, that very much depends on how monetary policy will develop and if the economy is heading towards a recession. But, despite all of this, we are very confident that technology will remain the number one investment area and the passion and excitement of venture for tech will be going nowhere.

 

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