“Capital is going to be hard to come by.” These words were uttered twice in the exact same way in two separate interviews with two financiers of the Additive Manufacturing industry. With a tumultuous 2022 marked by one of the highest inflations ever and a tightening of global monetary policy, hearing these words in fine, is not that surprising. Those financiers just expressed out loud what many people were thinking to themselves. So, yes, capital is going to be hard to come by, but what matters here and now, is the founder’s ability to understand this changing investment landscape and how they will adjust to get funded and grow their AM business. Helping executives and founders understand this “new” environment is what we ambition to achieve through this exclusive feature.
A couple of years ago, just before COVID-19, trade press of our industry were full of headlines announcing “Company X” raised money, leading to rapid growth, leading to more money being raised and so on. With those headlines, it was easy to feel we were living in an era of “free money” that fostered a “growth at all costs” mindset among many companies. These headlines had somehow defined “growth” as an important factor to get funded, to give credibility to a product that was not always or necessarily viable.
“If I look at investors perspectives – [understand here VC investors, private equity firms or public institutions] – and what they might be looking for at a given time, I would say they are currently being driven by the macro environment. During the last 5 to 10 years, we lived in a world with low to no interest rates, that was flush with liquidity, and that translated into to a very low cost of capital. Often times, high growth investments are in favour in that type of environment, and that had driven investors, especially VC investors, to embrace this “growth-at-all-costs” mentality. The idea is, if you grow and establish something, you don’t have to worry about profitability today as there would always be an abundance low cost capital in the future when it was needed. Profitability and cash flow generation could follow further on down the road”, Stephen Butkow, Managing Director at Stifel Financial Corp explains.
2022 saw a fundamental shift in the macro environment including continued COVID-19 lock downs in China causing both supply and demand issues, soaring energy prices resulting from the Russian invasion of Ukraine, and a rapid rise in interest rates as central banks looked to stem a persistent rise in inflation, all of which made investors more risk adverse.
“The problem is not always the fact that the rates are so high, but the fact that they expanded so fast. This has caused a massive rotation out of high growth sectors, such as Additive Manufacturing, which has made the fund raising environment more challenging for everyone”, Butkow continues.
Interestingly, the comment of Arno Held, Managing Partner at AM Ventures, completes in a certain way Butkow’s explanation, as he encourages to avoid generalization:
“Not only was this “growth-at-all-costs” mentality mainly observed before the crisis, it was also mostly observed in certain cultures/areas. Across various industries, some VC investors were looking for founders with such type of mentality to fund start-ups. However, today, the paradigm shift in the analysis process of VC firms and other financing companies puts on the forefront that there are more important goals to achieve within a start-up and these goals (sustainability, healthy revenues for instance), are often the ones to make the balance tilt in favour of an investment – thus making the “growth-at-all costs” mentality gradually become a thing of the past”.
“Growth-at-all costs mindset had this assumption that capital will always remain readily available and cheap. An unseen amount of VC money therefore was entering the ecosystem, changing the value-risk appreciation of investors across the VC ecosystem. With the current macrotrends, this has changed, leading investors to focus on sustainable growth. However, most importantly, growth and profitability have not to be mutually exclusive.”, Alexander Schmoeckel, Associate at AM Ventures adds.
Apart from securing financial rounds, mergers and acquisitions (M&As) remain the most highlighted route through which AM start-ups leverage financial resources. As a reminder, we recorded over 53 acquisitions (including SPACs) throughout 2021 – the biggest number ever reported since AM has been recognized as a true industry – over 21 acquisitions reported in 2022. The fact is, unlike in 2021 where the need for more financial resources was the main driver of these mergers & acquisitions, acquisitions reported in 2022 raised a number of questions regarding the real strategy of both buyers and sellers.
Is the seller only looking for capital? Was the seller only looking to grow their company until it is ready to be acquired? Does the buyer have a more thoughtful strategy in mind? Does the buyer just want to buy to kill their competitor’s business?
In the end, for who exactly are M&As a growth strategy, for the buyer or the seller?
For representatives of AM Ventures and Stifel interviewed, these are interesting but very complicated questions that absolutely require to look at both sides of the story: the acquirer and the seller.
“If done well, this can be a growth story for everyone”, Held points out. “Acquisition in itself is a capital investment. Now, the reasons of the acquirer always vary from one company to another. The acquisition can serve a very specific growth strategy in mind: [product development – new products in existing markets-, market penetration -existing products in existing markets-, market development -existing products in new markets- and diversification]. It’s a very rational decision that involves a thorough analysis that goes beyond financial resources to encompass the timing and go-to-market capabilities”, he states.
Butkow on his side lays emphasis on the seller side of the equation and his analysis pinpoints 4 items that in my opinion, should always be analyzed together: management strength (business acumen vs technology acumen), ability to scale, cost to access target market, definition of success or accomplishment – i.e. how far they want to scale the business. He explains:
“We surround ourselves with a lot of brilliant people who are typically mechanical engineers, computer science engineers or a mix of all of them, who have developed and turned great products into commercial business. And it’s very rare for a person to be an expert in one niche be an expert in everything. So, just being a fantastic engineer does not necessarily mean you’re a fantastic business person. The fact is, it takes a village to be successful, and grow a business. In this vein, it’s almost always accurate that a founder that takes a business from 0 to 10 million euros in revenue, is not the person that takes the same business from 10 million euros to 100 million euros, and so on. It requires a different skill set for every single milestone. That’s why there is very often a change in leadership every time a company achieves a milestone. Management quality is therefore as equally important as technology. It cannot just be overlooked.
On another note, our industry has failed many times because founders have been able to develop a viable technology but they don’t have a sound business model. Therefore, they found themselves in a position where they either have to constantly raise capital to scale or sell their technology to another company that already has all the infrastructures in place to implement a go-to-market strategy. At that particular moment, the founder is certain their technology is going to survive; it won’t survive in the exact form they initially planned, but at least it won’t die because of a lack of capital. It comes back to what was said earlier: the founder was the right person to move the business from 0 to 10 but is often times not the right person to move it from 10 to 100.”
Butkow’s explanation somehow opens up a more personal question every founder should ask themselves: what would make my business successful? Or how do I measure success? I know a couple of founders who take pride in building their company from scratch, every step of the way. I also know a couple of founders who are proud to have developed a technology, and scale it with the support of a parent company.
As Schmoeckel notes, “an entrepreneur might define [success] according to whether the new venture achieves personal fulfilment, an investor considers success more from a financial perspective, for example, whether the portfolio firm generates the desired rate of return. The most appealing approach to measuring success is by profitability. However, such data is largely unavailable to privately held companies. Differences between various investments in product and market developments enormously affect reported profitability. In addition, performance measures such as return on sales or net profit are more relevant for companies in their later stage. Early-stage startups are different, as they may initially have little or no revenue to report, and growth rates do not fully represent the real value of an early-stage firm”.
That being said, it should be noted that for VC firms – just one way AM Ventures considers success -, a successful startup is one that has secured at least a Series A VC funding round or has even managed to go public or be acquired by another company. A growing number of employees is also a direct indicator of growth for VC firms, as it serves as a proxy for the growing managerial complexity.
For that to happen, founders or executives should be able to raise capital every “18 and 24 months. This timeframe should be the ideal way to go. This means that founders should establish business plans that last about 24 months – knowing that money always goes faster than expected”, Held outlines.
What should founders be considering to grow their AM business?
So, yes, with the macroeconomic projections, there are potentially some very challenging times ahead. Some companies will struggle to raise further capital but this does not mean it will be impossible. As Held says, “we should be careful not to fall into a big “panic” move”. No matter what the projections say, “at the end of the day, investors are buying risks. The most-risky investment in the world is a start-up. [However,] investors need to understand why the solution they invest in, needs to exist. [There must be a compelling customer value proposition]”, Butkow states.
I think, we can all agree that growth for growth’s sake without a sanity check on efficiency, sustainability, or profitability will bring you nowhere. Based on our conversation with these three experts, we can summarize some of the crucial points that may require specific attention as follows:
- Investment in the private AM market is being explored and that there are still opportunities despite the changing investment landscape
- Funding will likely be more applications vs technology based.
- Customer adoption should be a key area of focus.
- VC firms like AM Ventures will be looking at companies that achieve profitability right from the start. Not achieving profitability within a year or two will not be a deal breaker but do not make ridiculous assumptions on your profitability.
- Investors will be looking at start-ups that have a great management team. As capital becomes more uniform, the quality level is usually on the management side, so they will be looking at the team who will be able to bring the company to the next phase. Management teams who will be a bit honest on their story and where they will go, will attract more capital.
- A working business model and a strong leadership should not come at the expense of value or the team behind it.
- Big companies that went public and made a lot of promises on growth will be evaluated both on growth and profitability.
- Investors almost always go back to the basics. That’s a world were cash is expensive, people have to be disciplined with their cash.
- Investments are principally made with an expectation of a rate of return based on a future value discounted back to today – will it be worth more than it is today in some defined time period?
- Consolidation will happen for a multitude of reasons
- Reasonable Valuation vs 2020/2021
- Need for / Ability to attract capital
Need for scale to achieve profitability – lack of operating leverage
A few words on AM Ventures and Stifel
If you’re a regular reader of 3D ADEPT Media, you probably already know AM Ventures, this VC firm that decided to grow the entire industry by investing in forward-thinking AM companies across the materials, software, hardware and applications fields. With 17 portfolio companies across the world, AM Ventures emphasizes the need for companies seeking funds to choose the “right investor” and “to prioritise collaborations over acquisitions”.
Stifel is a diversified global wealth management and investment banking company with a focus on serving small and mid-cap companies. Their investment banking division provides M&A advisory, capital raising and equity research. They are one of the most active investment banks in the AM sector being involved in over 20 transactions, over the last two years, including the likes of advising ExOne on their sale to Desktop Metal and 3D Hubs on their sale to Protolabs.
This article has first been published in the January/February edition of 3D ADEPT Mag.
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