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Exchange rate volatility affects almost all startups – not just those which operate across borders. Understanding how these dynamics work is vital for investors, as it may affect whether or not you deem a specific startup worthy to pass your due diligence requirements. In this guide, our team at Bure Valley Group explains how currency markets affect startups and some strategic implications for your portfolio.
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Currency markets & startups
The foreign exchange (FOREX) market occurs around the world, over the counter, involving the trading of different currencies such as GBP, Euros and USD. Investors try to make a profit by buying currencies which they expect to rise relative to others, then selling (before they fall) to repeat the process elsewhere. As a result, currency markets are highly volatile. They never stop and the participants include individual traders, banks and investment firms/funds.
A startup can be directly affected by currency fluctuations in at least two ways: 1/. When selling overseas; and 2/. When buying from overseas. With the former, it becomes harder for overseas customers to buy a startup’s goods/services if these are sold in GBP but the customer’s own currency falls in value relative to it. On the other hand, if a startup submits invoices in a foreign currency then, if the exchange rate moves against GBP between the date of invoice and the date of payment, then the business receives less money.
When buying from overseas, furthermore, a startup’s bottom line can be undermined if GBP weakens in relation to a foreign supplier’s currency. Your currency cannot buy as many goods as before for the same amount of GBP.
Startups can be more vulnerable to currency fluctuations compared to large international firms. The latter may be able to source goods for their product within an overseas supplying country, and also sell to customers in the same currency. An early-stage business, by contrast, tends to be small with its team concentrated in one jurisdiction (e.g. the UK). If customers and suppliers are based abroad, then it may be impossible to do business in the same currency.
Just because a startup doesn’t have customers or suppliers overseas does not mean that currency fluctuations cannot impact them. They can still be indirectly affected. For example, suppose a startup makes heavy use of delivery trucks across the country (to make deliveries). Here, fuel prices could go up due to exchange rate volatility (since it is priced in USD) and can, therefore, lead to higher shipment costs – eating into the startup’s margins.
Another scenario might be that GBP falls relative to USD or Euros, leading to higher costs on imported goods. This, in turn, could lead to a lowering in overall import volumes to the country. Here, certain startups might benefit since customers would then likely turn more to domestic companies to meet the demand – leading to more jobs, increased sales and higher profits.
Angel investing & currency risk
Exchange rate volatility is sometimes overlooked during a startup’s due diligence process on a startup. However, for reasons shown above, it is vital not to overlook this. Here, an examination of the startup’s business model can help illuminate some of the risks involved.
Suppose a startup is looking to sell cosmetic products to a UK customer base. Where do the materials for the different products come from? Would there be any supply issues if GBP fell in value relative to an overseas supplier’s currency? If your founders have thought about this and lined up back-up suppliers (e.g. in the UK) in case things go awry, then that is a good sign.
Another positive signal from a prospective startup investment is the founders’ consideration of using forward contracts when dealing with overseas suppliers. These agreements fix the exchange rate between two countries for a specific period of time. Although this can sometimes lead to missing out on profits (i.e. if GBP strengthens between the purchase and payment date), it can be vital to help protect against supply issues if currency markets move against the startup.
SaaS companies are currently popular candidates for angel investing portfolios. Here, also, FOREX issues need to be borne in mind. In particular, which currency will the software be sold in? UK companies with a target customer base in the UK will likely deal in GBP, minimising most issues initially. However, in the future it is not inconceivable that many SaaS companies will see their product(s) picked up by overseas customers. At this point, a strategy will be needed to help ensure profitability over the long term – throughout different exchange rate conditions.
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