SME Tech on the Verge of a Breakthrough
SME Tech funding deserves another look as the market is evolving
Lack of VC interest in SME Tech translates to fewer innovations for SMEs
VC interest in technology solutions for small and medium-sized businesses (SME Tech) has been low or non-existent for the last decade. The lack of VC interest in SME Tech startups has contributed to a big rise in the number of startups founded to address the challenges faced by enterprises (Enterprise Tech) and fewer startups targeting SMEs and their needs. Our research (historical deal flow data and Crunchbase data) shows that startups targeting SMEs make up roughly 30% of B2B startups in the DACH market.
This, in turn, means a much higher number of Enterprise Tech startups competing for a relatively low number of addressable customers and revenue in the enterprise software market. As the diagram below illustrates, the number of enterprises addressed by startups is disproportionately lower compared to the large customer set of relatively few SME Tech startups.
The lack of VC interest also becomes clear when comparing VC investments in Enterprise Tech to VC funding for SME Tech as the chart below depicts:
We believe that the market is changing and investments in SME Tech should, therefore, be reevaluated and more attention paid to it. As seen in the diagram above, the volume and amount of SME Tech funding are picking up, while funding for Enterprise Tech is simultaneously decreasing.
VCs have good reasons as to why they are reluctant to invest in SME Tech startups
In many cases, arguments against funding SME Tech are based on years of experience in investing in this space. Some of the key reasons cited by experienced VCs include:
Customer acquisition — SMEs tend to operate in long-tail fragmented markets, making their acquisition difficult.
Purchasing power and average order value — SMEs usually have lower purchasing power in comparison to larger enterprise counterparts. Therefore, SME Tech startups have to acquire a larger number of customers in order to create a profitable business that will yield an attractive ROI for founders and investors alike.
Churn — SMEs have fewer employees. They can easily move these employees to other service providers. This makes it much harder to “lock-in” SMEs and poses a higher comparative churn risk.
Capturing value — Oftentimes, SMEs move to enterprise solutions once they have reached a certain maturity or size as their needs become more sophisticated. The result is that they move their profitable business with bigger basket sizes to an enterprise solution offering more functions.
Bankruptcy — SMEs have a higher risk of bankruptcy compared to their larger counterparts. In 2019 for example, 99.2% of all bankruptcies in Germany were filed by companies with less than 100 employees.
Potential risk/reward — Many investors are deterred by the small number of successful SME Tech exits as an indication for a rewarding venture in the SME Tech sector.
SME Tech deserves more love — The market is evolving favorably for VC investments
Although the aforementioned arguments are totally valid in many aspects, I believe that the SME market is evolving. Regulatory and market conditions, economic incentives, and customer behaviors are changing; so SME Tech deserves another look. Current developments in the SME sector represent opportunities that, if seized, can translate into a profitable business:
SME digitization has just begun, it is accelerated by the COVID crisis, and poised to grow
- Due to the COVID crisis, we are seeing an increased demand for digital solutions from SMEs. 80% of SME decision-makers want to become more digital, while only 12% view their company as fully digitalized.
- A more digitally-literate generation of SME decision-makers and workforce is moving into the SME sector. By 2022, a total of around 150,000 successors are expected to take over SMEs in Germany alone.
- Future of Work and remote work caused by the Covid-19 also means an increased need for digital solutions for the workforce.
- The number of robots in use worldwide is growing significantly. It has tripled over the last two decades. The lack of skilled labor or the rising costs thereof makes robotic and automation solutions even more attractive for SMEs. According to this Mckinsey research, about 50% of current jobs globally could be automated. In the EU, between 37% to 69% of jobs could be partly automated. This compilation of research by the European Commission is a good source on the impact of automation and robotisation on jobs.
- For more information on the current state of digitization among German SMEs take a look here, at this research, or at this one (from Page 29).
Cheapening access to new technologies
- Democratizing of, and cheapening access to, AI technology and Big Data & Business Intelligence & Analytics solutions for SMEs has led to an increase in its adoption. For example, I’ve seen a rise in startups in our funnel (though still in its infancy) providing SMEs with no-code platforms to create AI solutions for their businesses.
- There is also an increase in adoption cloud of technologies by SMEs. Drivers of this trend are the limited IT resources coupled with an increase in cyber attacks. In addition, the cost savings in hardware that can be achieved through using cloud solutions are also leading to them taking off. For SMEs, Covid-19 is fueling cloud migration as remote work becomes the norm.
- As e-commerce becomes normalised, consumerization of B2B commerce makes selling to SMEs easier than before. Leveraging familiar B2C technologies allows B2B buyers to purchase directly from stores without having to consult a sales representative.
- In this insightful post by James Currier, Managing Partner at NFX, he gives six reasons why he thinks B2B commerce has changed favorably for tech entrepreneurs. Some of these reasons are; higher internet penetration, increase of mobile and IoT devices allowing for automated inventory/reselling/tracking, and also enabling easier provision of B2B serviced or managed marketplaces, etc.
Regulatory developments — new federal government awareness and incentives
- To empower small and medium-sized enterprises to exploit the economic potential of digitization, the German Federal Ministry of Economics and Energy (BMWi) has launched the “Digital Jetzt” program. The program’s purpose is to provide subsidies for investments in digital technologies and in digitization-related training for employees.
- Regulatory changes like the “Belegpflicht” 2020 in Germany with similar legislation in France, Italy and Greece, the “Batteriegesetz” in Germany or European and national data and privacy regulations (GDPR) are also a catalyst for SME digitization.
- For example, SMEs must now consider pseudonymization or anonymization technologies where appropriate to protect personal data they collect and use.
About signals Pre-Seed
signals is your trusted business partner, mentor, and investor in one. We support founders with more than money.
The signals Pre-Seed Program invests in B2B software-based solutions for small and medium-sized businesses as well as in category-defining solutions for enterprises in the DACH region. We invest up to €250k to provide early-stage founders with an adequate runway. In addition to this, we provide founders with individualized mentoring and office space where and when needed so they can concentrate on what matters most — working on their product and gaining customers.
