All of the coffee shop buzz this week has been about the S&P downgrade. Technicalities aside1, there is no doubt that it will fundamentally affect our economy, possibly for decades – it took Colombia 12 years to regain investment grade status after being downgraded. The question for you and me is does the same gloom hang over the startup space?
To answer this we look at it from two technical perspectives: the funding environment and the operating environment.
Fortunately, or unfortunately, we do not have the likes of Sequoia and other big funds pouring their foreign capital in to our startup market. We’re running on local fuel in the main, this means that our money is stickier, it is here for the long run. International funds are more sensitive to shifts in risk-return profiles of this nature. They’d be shifting their focus to another market or more be aggressive in their negotiations to mitigate the increased risk.
True, the cost of capital will increase with the downgrade2 and this may result in less funding being available. However most startup funding in our market is discretionary capital and a small portion of the typical investor's overall portfolio. As a result, they are less sensitive to the cost of capital and we don't expect a significant draw down of funds available.
There are obvious knock on effects which no one can escape. A falling Rand means we’re likely to import inflation. Items like petrol affect all businesses, even if you’re riding your bicycle to the closest co-working space you’re still going to be paying more for other consumables like food which use trucks to transport goods. Expenses will go up. However, the revenue upside is less affected because startups don’t apply typical business models. The disruptive ones create markets, they find new ways of making money.
Entrepreneurs are inherently optimistic, otherwise we wouldn’t have taken the crazy leap of faith required to pursue our passions. You could argue that I’m looking for a silver lining but it is for the reasons listed above that I believe startup investing has stolen a march on traditional asset classes because of the downgrade. Shares listed on the JSE, bond markets and currencies have seen volatility since the announcement. It’s hurting investors’ pockets. For the startup space, I see it as nothing more than a mosquito in the room, a temporary irritation.
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I’d welcome any other thoughts, please get in touch.
1. S&P downgraded the country’s local and the foreign currency debt, though only the foreign debt is considered below investment grade. One of the other two ratings agencies would need to downgrade the foreign component of South Africa’s debt in order for the country’s foreign currency debt to be officially considered below investment grade. Moody's and Fitch are yet to update their ratings.
2. Downgrades imply a greater risk premium which typically result in lenders increasing interest rates to compensate.