Which startups will benefit the most from a strengthening greenback? And will changes in the value of major currencies lift any particular region?
The U.S. dollar is having a good year. The U.S. Dollar Index, which tracks the value of the dollar against other currencies, for example, bottomed out at around 95 points in early January. Since then, the metric has appreciated to 106.69 points as of today — and we’ve seen the U.S. dollar reach parity with the euro, the latter currency having enjoyed a premium over the former for the last 20 years.
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The changing relative value of major currencies is impacting technology earnings. American tech giants, for example, reported large currency-related impacts on their Q2 results. Microsoft grew 12% in the second quarter of 2022 – but 16% if we stripped out the impact of currency swings. The same issue also cost Microsoft five percentage points of net income growth in the same period.
Microsoft was not alone. Outgoing Meta COO Sheryl Sandberg said during her company’s latest earnings report that changing currency values “had a significant impact in Q2, in particular the depreciation of the euro relative to the dollar.” Indeed, the now-infamous year-over-year revenue decline that Meta reported in the second quarter would have actually been 3% revenue growth had currencies stayed put, Sandberg said.
Smaller tech behemoths are also seeing exchange issues impact their results. Yesterday, Airbnb said that its 58% revenue growth in the second quarter would have been 64% “excluding the effects of foreign currency fluctuations.”
But not all the news is bad for tech companies. If we observe only the impact of changing currency values on U.S. tech companies with large foreign sales, sure, the stronger dollar is shrinking the USD value of their sales overseas. But what about, say, European tech companies? European startups? Are they benefiting from dollar-euro parity?
Expectations are that the current exchange rate between the American and European currencies is here to stay. So whatever impact we can infer could be lasting, too, implying something akin to a new normal for European startups.
What is the possible impact? Well, a strong dollar makes deals in Europe potentially cheaper for American investors and could make selling abroad more attractive to euro-denominated startups, right? Let’s talk about it.
The basics of weak versus strong currency, applied to startups
A weak euro hasn’t been seen in such a long time that it is worth recapping what it means for businesses and, in particular, for startups.
As illustrated by Big Tech earnings for the past quarter, a weak euro creates headwinds for exports from the U.S., since it makes imported goods and services comparatively more costly for Europeans to acquire.
Conversely, euro-dollar parity could be helpful for export-oriented European tech giants — if it had any. But PitchBook EMEA private capital analyst Nalin Patel reminded us that creating companies of that size isn’t exactly one of Europe’s strengths.
“In Europe, we are yet to see companies with comparable market capitalizations to the Big Tech FAAMG (Meta — formerly known as Facebook, Amazon, Apple, Microsoft and Alphabet’s Google) group,” Patel said.
While being smaller, startups and scaleups that mostly focus on foreign markets could enjoy tailwinds from their products effectively becoming cheaper for some customers. This type of startup is fairly common in Europe’s smaller countries, where building for one’s local market or language is not enough.
In Europe’s larger markets, selling to the U.S. right away has been less of a necessity but could become more of a priority as dollar-denominated revenues become more alluring. This could be especially true for startups whose products and services are digital, meaning that selling to clients abroad isn’t that much more expensive than selling domestically but brings the same currency conversion advantage as selling physical goods.
Scaleups that already made a big U.S. push could also be rewarded for their efforts, and we will track this data point in their next earnings and fundraises. (Klarna, for example, has invested to grow in the United States, which could pay dividends.)
One of the biggest uncertainties for European businesses in the near term is how they will weather a rise in costs: Inflation is a global issue but an even thornier one in Europe. Not just because of energy concerns, but also because the European Central Bank has less margin to avoid a recession.
However, compared to other businesses, startups are less dependent on the type of goods and services whose prices are most likely to rise. Except, perhaps, for payroll.
One of the biggest complaints across Europe is that salaries and pensions haven’t risen as quickly as inflation — at least not yet. Despite being wary of taking action due to fears of a wage-price spiral, governments might eventually give in; but this would mostly apply to legal requirements such as minimum wages. Tech workers typically already earn more than that, with salaries that are more impacted by demand than by regulation.
If costs do end up rising more slowly than prices of sold goods, this could be a win for European startups. And while this might not be enough in itself to make them more attractive to foreign investors than they already were, it is worth looking into whether a stronger dollar could also influence venture capital allocation.
Will a stronger dollar impact venture flows?
If we consider the question from the perspective of American investors flush with a strengthened currency, we might anticipate more interest in European deals. After all, if a round is priced in euros, and an investor holds dollars, they may be able to get an effective bargain on the check they write. And who doesn’t love discounted prices?
But Index Ventures’ Martin Mignot, who has worked in both the U.S. and in Europe, doesn’t foresee too much impact. Why? Because Index invests in a seven- to 10-year time horizon, “short-term [foreign exchange] movements are not very relevant.”
If American investors aren’t going to shake up their overall geographic thesis thanks to a stronger dollar, what about international investors that put capital to work in both the United States and Europe? Mignot doesn’t expect those firms — like Index, for example — to change their capital allocation strategy.
The investor again said that venture firms think in half decades or more, noting that no one knows what currencies will be worth that far in the future. So, if you can’t forecast the currency impact of a potential future exit, it’s hard to say with confidence today that a deal that looks cheaper thanks to, say, a strengthening dollar, will actually wind up generating more yield compared to invested value.
Still, people respond to incentives, and investors are just folks. Therefore, the near-term strength of the dollar may have some impact on deals that are perhaps a coin-flip for investors; U.S. dealmakers on the fence may find a stronger dollar to be a nudge toward conviction, if not enough to truly change behavior.
It appears that the changing currency market and the weakening euro could lead to a focus shift among European startups to sell more in the United States but isn’t likely to make material changes to the venture world. We’ll check Q3 data when we get it to see whether the flow of deals across the Atlantic agrees with or runs contrary to what we’ve learned today.