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Michael Novinson: Hello, this is Michael Novinson with Information Security Media Group. We're going to be talking about cybersecurity startups in the economy with Dino Boukouris. He is the founder and managing director at Momentum Cyber. Hi Dino, how are you?
Dino Boukouris: Great. How are you?
Novinson: Doing really well. Thanks for making the time here. We've seen a lot of discretionary budget cuts over the past year, given the high interest rate, high inflation environment we are in. Why do those discretionary budget cuts have more of an impact on early-stage startups than established cyber vendors?
Boukouris: So, typically, when you say discretionary, or I call those the innovation budgets, it's cyber spend that is not part of the core kind of must-have technologies, like an endpoint security company, they're not going to suddenly slash the budget. The staples, I would say, are always going to have healthy budgets. In an industry like this, they continue to go up into the right, where these innovative startups that have either nice-to-have solutions or should-have solutions, but they're just not in the top priority for the professionals, or if it's some new capability and new visibility that they're unlocking. It's harder for those budgets to get approved nowadays, which, as you can imagine, just based on how I describe these budgets, that tends to skew heavily toward the startup ecosystem. Those are the innovators. And those are the ones that have kind of the latest and greatest technologies; doesn't affect like the Palos and CrowdStrikes and others in the world as much.
Novinson: Interesting. So in terms of innovation budget, other particular technology areas within cybersecurity that you feel have been hardest hit by the economic downturn where all organizations have maybe pulled back from spending.
Boukouris: I wouldn't say there's like a particular sector, per se. There's up-and-coming sectors. And there's newer areas, like whether it's data security, some new innovative identity technology, or risk management technologies, across the cyber industry, there's always either you're kind of a nascent sub-sector or reinventing something in that space. So I don't think there's like a disproportionate or heavily skewed toward one versus another. But just, in general, like the more innovative solutions tend to be the ones that take a bit more convincing.
Novinson: So in terms of slashing this innovation budget, what does this mean for the early-stage startup community? How has the impact been felt over the past 12 months?
Boukouris: I'd say when you look at softness and performance. So, looking at what they forecast versus what they achieve in terms of sales. You'll, as expected, those are the companies that are either missing their numbers, because they're just like getting the budget approval, or sometimes they might win a deal or have approval, but they need to wait a quarter or two for those funds to get unlocked and released. That's the other thing we're seeing - it's not just that they're not able to make the sale, it's that they're just having to wait a longer period of time. So sales cycles are getting longer, which as you can imagine, if you're a startup, you're burning a ton of cash, you're kind of scaling your expenses in line with what you're projecting for your revenue. So when your revenue gets kind of pushed out, you then start having a situation where you're scaling a bit too fast. So you might have higher burn kind of coupling between the challenges that we're seeing, raising capital in the current market, kind of coupled with sales cycles that are getting extended, and softness in their forecasts. It's kind of creating a perfect storm for making these companies have a bit of a challenge, I would say, relative to 2021 or 2020.
Novinson: So one of your options then is do you see people looking to exit the market? Are they looking at layoffs? What's happening at the startups that are perhaps not hitting their numbers?
Boukouris: All the above, I would say. Layoffs unfortunate, but we've seen that happen. Oftentimes, companies also are just not willing to throw in the towel quite yet. So instead of raising around the capital at a significant bound round to what they raised the last time around, they might do a convertible note or some kind of a safe structure, something that effectively kicks the can down the road on the valuation. And, they're able to bring in some cash to kind of bridge them for 2, 3, 4 quarters, however long they think this period is going to last. So that's kind of option one. Option two would be to do some kind of layoffs and kind of bring those expenses back down more in line with the growth that they're seeing. And then of course, option three is if they're not able to either raise capital or find some creative source of capital and layoffs aren't enough, they might have to consider an exit. So you're seeing a lot of M&A activity. So the number of deals might be reasonable and decent, but the actual deal sizes and kind of the quality of those assets, I'd say are a bit lower today than they were two years ago in Q1.
Novinson: Let's say that's because often these companies have already made cuts before deciding that they have to sell or why does that happen?
Boukouris: That was just survival of the fittest. So you tend to see the stronger, more mature companies that have strong business fundamentals, they're able to raise capital. So it's unfortunate, the weaker companies, maybe the ones that haven't been performing as well, that had to make cuts, and they're just forecasting lower growth in the future. All of that kind of combines to make those M&A targets just a little bit lower quality, not all of them. We saw HPE-Axis deal get done, high-quality asset, healthy premium being paid there. Cisco with Lightspin, Valtix. So there's so many strategic deals that are happening. But just I'd say the majority of them fall in the other category of just companies that are struggling a bit, and just looking for a soft landing.
Novinson: In terms of the convertible notes. I know, we saw two high profile ones Netskope and Arctic Wolf do that. How common has it been among earliest stage smaller startups? First off, and then secondly, what do you feel the impact is going to be in the medium to long term that they're getting the capital via convertible note, rather than the equity - the more traditional route?
Boukouris: Debt typically has a clock associated with it. So when you start taking in debt, instead of raising equity, you put a lot more pressure on the company? And depends on the structure. And there's a wide range of these types of instruments. But I would say, you try to shy away from debt being an earlier stage company, one, because it's tough to service the debt. It's hard to make interest payments if you're burning cash, and you're not cash flowing into if you have some kind of structure that you don't have interest payments. But maybe, there's a balloon payment likely comes due to three years down the road. Again, it just adds a layer of complexity. And also, when you go to raise your next round of capital, oftentimes you need to raise around not just-enough capital to fund the business, but to also take care of whatever obligations you have associated with that debt.
Novinson: Interesting. So in terms of those points you outlined, you talked about layoffs, debt financing and exit via M&A. Which path are you seeing most companies follow and why?
Boukouris: I'm not sure if there's one versus the other. A lot of times, it's a combination. Typically, you wouldn't see a company just try one approach and that's it and then throw in the towel. Usually, you're going to see some combination. They might do a little bit of headcount reduction, and they might tap some of the debt markets. But again, if you raise enough that maybe keeps you afloat for two quarters, and the slowdown has lasted longer than two quarters that means you still might end up going and taking path number three as well. Or some people buy themselves a bit more time, they hit their numbers, and are able to raise equity. So there's more than just those three paths, but it's never usually just one solution.
Novinson: For those companies who are able to raise equity, why are investors today focusing more on business fundamentals than vision or team?
Boukouris: I think the notion of growth at all costs is just I wouldn't say it's out of the window, but it's very hard to find kind of capital, if you're a business that's just burning. I won't give the exact metrics. But if you're burning kind of disproportionate amount relative to your growth, you're going to be in trouble in the current environment. So that pendulum kind of swings between growth and profitability. It's kind of swinging back to profitability at this point in time. So I would say they're looking at things like gross margin, retention, whether that's burn efficiency, magic numbers, there's a lot more focus on the union economics. If they were to pour additional capital kind of into the engine, they want to see kind of predictable revenue on the backend. So they're just kind of measuring three times and cutting once, if you will as opposed to I'd say what the environment was like in late 2020 and early 2021, where capital was a bit more free flowing.
Novinson: And finally here from a M&A standpoint, I know, you said the volume of deals is healthy; however, deal size is down. What are the implications for startups who are considering an exit the fact that deal size is smaller today?
Boukouris: So it's an interesting question. It's not so much that the rest of the deal sizes are smaller. It's more about kind of how companies are being valued? When you look at the public markets, and you have high fliers that were trading at 50, 60 times revenue, and now trading at seven. That creates a problem. And that is you are a private company, you're trying to justify some revenue multiple to calculate what your business is worth. It's tough to say you're worth 30 times revenue, if the leaders in the space are worth eight or nine or 10. So I think there's kind of pressure that's being put - downward pressure on how you would value a business. And then the overall kind of comp set if you will as it relates to M&A when the last two or three companies to be sold in your space were sold at a low price, it's harder to justify your prices. It's like real estate. If all the houses in your neighborhood are being sold at a low value, it makes it even harder for you to ask for something that's a premium to those houses, because a lot of times, you will look at the comparables and that's how they triangulate down to a number. It's not always scientific. But I would say that a lot of these factors, unfortunately, are pointing in the downward direction when it comes to triangulating on numbers. So it's a challenging environment to sell your business and kind of attract a premium price for it.
Novinson: Interesting perspective. Dino, thank you so much for the time.
Boukouris: Thank you. Appreciate it.
Novinson: You're very welcome. We've been speaking with Dino Boukouris. He is the founder and managing director at Momentum Cyber. For Information Security Media Group, this is Michael Novinson. Have a nice day.
