Irish tech start-ups must keep calm and preserve cash to survive what’s coming

Last week payments firm PayPal announced a second round of job losses at its operations in Dundalk and Blanchardstown. From a high of about 2,800 a year ago, this will bring its employment down to about 2,000. However, PayPal is not the only technology company to announce a reduction of its cost base: worldwide, hiring freezes and redundancies are rippling across the sector. Amazon, Facebook, Microsoft, Nvidia, Twitter and Uber have all announced a worldwide slowdown or pause in hiring. In China, video gaming and social media giant Tencent has announced job cuts, and the ecommerce Alibaba Group is undergoing several rounds of job losses across a number of its divisions.

Why are the brakes now coming on in the technology sector? One reason is the return to work after the pandemic. As the pandemic took hold, companies that enabled working from home and offered home entertainment blossomed. Zoom (video calling), Netflix (entertainment streaming), Robinhood (stock market trading), as well as Amazon in ecommerce, Microsoft and Apple and others with smart device products, and of course the social media giants, all saw their markets expand. Their valuations rapidly grew and there was even more than the usual hype around the technology sector. Now, as the pandemic is apparently receding — at least in the western world — leisure time and computing use at home are falling as staff return to more regular work practices.

But there is a global economic backdrop, too. There are deep disruptions of supply chains, and the pandemic continues to place Chinese manufacturing — including of computer systems and electronic devices — under pressure. The Ukrainian war is threatening substantial disruption of grain food supply, as well as potential recession across Europe as embargoes on importing Russian petrochemical-based energy products bite hard. The US has a demographic challenge, with an ageing population and a labour shortage threatening. China too may no longer be the low-cost manufacturer for the planet, with a declining available workforce as the working-age population peaks. With shrinking labour pools, wage costs are rising at the same time as energy and transportation costs are rising.

The Consumer Price Index inflation measure is now at 7 per cent across the EU, 8 per cent in the US and 9 per cent in the UK. To try to dampen this inflation, some central banks are increasing interest rates. In early May the US Federal Reserve implemented its largest interest rate rise since 2000 in response to the current 40-year high in US inflation. Nevertheless there is debate: some economists expect that inflation will naturally decline as consumers restrict their spending away from discretionary items back to food, energy and accommodation — the essentials, whose costs are now strongly rising as a proportion of income.

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If consumers are going “back to basics”, it is unsurprising that discretionary entertainment and consumer computing purchases are falling. Between 2019 and 2021 the S&P 500 — a list of the top 500 US public companies — grew nearly 75 per cent, reflecting government stimulus in response to the pandemic and the expansion of the high technology sector and consumer discretionary stocks. But now in 2022, the index is surrendering its gains, down some 18 per cent since January. Stock market investors are increasingly wary of the hype and expensive valuations of technology stocks, and so it is not just consumers who are thinking “back to basics”. Energy stocks now appear attractive, as do defence industry stocks as the world responds to the Russian tensions. Cheaper stocks (as measured by their profit/earnings ratio) are showing much better returns than their expensive technology sector stock peers.

What does this all mean for the innovation sector and start-ups? In 2008, Sequoia Capital — a Silicon Valley venture capital firm — circulated a now infamous memo, “RIP Good Times”, to its portfolio companies and investors. In response to the then global banking crisis, Sequoia forecast extremely tough times for start-ups and demanded that each of its companies “spend every dollar as if it is your last”. Today, some in the Valley are equally gloomy and believe that the current collection of hiring freezes and job losses in the high technology sector are the start of an implosion. Because start-ups are frequently collaborating and selling into the high technology sector, contagion from those companies already under pressure may well rapidly infect others across the ecosystem.

At the same time, most venture capital investors are instinctively reacting to try to protect their existing portfolios, preserving funds for follow-on investments in their start-ups and so generally avoiding expanding investment into new companies. While it is always competitive to try to attract a term sheet from a venture capital firm, now only the very exceptional start-up opportunities may be able to do so.

What does this mean for the Irish start-up scene? Over the months ahead, it may become even more difficult to get funding. Back to basics is the order of the day. Build markets, sell, but only do so profitably. Preserve cash, and ensure you efficiently collect it from your customers. Look for opportunities for supplementary cash from grants and awards. And: stay calm.