Tighter capital markets will test travel startups

For many travel companies, navigating the past two years has proven to be more difficult than normal. And recent financial market volatility has compounded the pain, leaving many businesses ill-prepared for this post-pandemic environment. Unchecked inflation, interest rate normalization, turbulent labor markets and pandemic-related supply chain challenges have contributed to a weaker appetite for relatively riskier asset classes such as travel startups.

This cycle reset, while painful for some, will ultimately create more valuable businesses and a healthier industry through greater operating and funding discipline. As former CEO of Cisco System, John Chambers Noted“Marginal startups just won’t get funded, but I actually think that’s a healthy phenomenon.”

Let’s take a look at how we got here and what businesses can do to better withstand this cycle.

“Planning for the worst”

It is instructive to frame this business cycle around bookends. On the one hand, policymakers turned on the taps in the spring of 2020 to fuel economic activity by lower interest rates and shake up the economy with massive government transfer payments to businesses and individuals.

Capital markets were abundant with liquidity, which supported valuations in almost all asset classes – from real estate to technology companies. According Crunchbaseventure capital investments in 2021 have reached record levels, measured by both the number of transactions and the funds invested.

Many great companies will go through this cycle with challenges – none of which are existential.

Bryan Auchterlonie

SPACs, an unusual liquidity vehicle, have flourished with several travel agencies including Sonder, Vacasa, Wheels Up and Inspirato using them to raise capital at enticing valuations. Capital flowed in and confidence reigned.

Unfortunately, policymakers have been slow to recognize the speed at which post-pandemic economic activity would pick up. Earlier than expected, we are now at the second end of the cycle: a historical inflationary context and one in which investors both expect significant interest rate hikes but are highly skeptical of policymakers’ ability to outpace historic inflation.

In this environment, investors reassessed risk by discounting growth, assuming higher production costs for goods and services and, therefore, reducing projected corporate profits. Those same companies that have used SPACs to access capital have seen their valuations reduced from around 2.5 times the enterprise value to future earnings ratio to less than half today.

Venture capital investment in the first quarter of 2022 fell 13% compared to the same period in 2021. “No one can predict how bad the economy will get, but things don’t look good,” wrote investment firm Y Combinator in a letter to its portfolio. founders. “The safest move is to plan for the worst,” the firm wrote. While capital continues to flow, confidence has weakened.

Try the challenge

Our travel agency ecosystem includes an assortment of innovative companies large and small, all vying to improve the traveler experience. Many great companies will go through this cycle with challenges – none of which are existential. However, early-stage or mid-stage growth companies with small capitalization will be more exposed and will need to react more quickly and with greater clarity to avoid greater vulnerability.

For companies that do not plan to lift a new cycle, they should quickly review cash burn rates and execute their business plan until the sunnier days return. Regardless of a company’s relative financial health, it should promptly review its business assumptions, including cash flow projects and remarks assessments, and, if necessary, implement cost reductions. to provide a healthy cash reserve.

However, if capital is needed within the next 24 months, they should plan for a longer and potentially unsuccessful capital raise. As part of capital planning, companies should consider an internal cycle and a dilutive complement to previous cycles to ensure adequate cash flow.

In addition, they should expect a shallower pool of more attentive investors, demanding operating performance due diligence, a shift in investor capital stack preference (equity with debt), a higher overall cost of capital and a renewed emphasis on the viability of capital return plans.

This current cycle will not be the death knell for most businesses, and many businesses will thrive in this environment. However, they should be prepared for less forgiving investors in companies that lack industry differentiation, healthy balance sheets, favorable unit-level economies, and in-place or clear free cash flow. If companies don’t clearly address these elements in their business planning, it’s time to get to work.

Finally, and as we saw during the first end of this cycle, there will be opportunities for consolidation by merger, split, sale or acquisition. An uncertain capital market cycle can be frustrating, but patience, good planning and disciplined execution will prove to be valuable.