Rude VC: Year of the Draghi

Sep 18, 2012
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It appears that rumors of the death of the Euro have been greatly exaggerated, at least for now. This is thanks in large part to the efforts of the President of the European Central Bank, Mario Draghi.

Mr. Draghi seems to have made all the right moves so far. He successfully convinced Germany to accept the ECB’s proposed bond purchase program, neutralizing the critics at the Bundesbank and winning the confidence of Chancellor Merkel. In parallel, he rendered the program viable by making aid conditional upon the commitment to structural reform and fiscal discpline by any member state.

One result has been the sharp climb in the value of the Euro, which has rebounded to a value of $1.31, up from $1.21 only slightly over a month ago. While relief from the depressing decline of the single currency provides grounds for optimism about the common market, these short-term swings can prove dizzying for European businesses that export outside the Euro-zone.

Especially inconvenient for startups

European startups may be particularly jostled by the currency whiplash effect. Many segments of tech firms (enterprise software, to name one) are more likely to have a significant revenue base in dollars while the bulk of their cost base often remains in euros. For small and medium businesses in this situation with relatively limited budgets,  currency volatility can wreak havoc with cash flow, which as we know, is always tight in startups anyway.

This problem will not dwindle away. Tech startups are increasingly selling to worldwide markets. By nature, they do not splurge on sophisticated financial departments, and they possess neither the resources nor the volumes to warrant elaborate currency hedging methods. There are, however, some best practices that young companies can consider to limit their exposure to foreign exchange swings.

Even for startups, there may be hope

First, small firms should consider operational currency hedging techniques. Operational hedging is essentially the practice of matching revenues and expenses in the same currency. For example, an IT services firm might pay its salaries in dollars to the consultants who service U.S. clients, and in euros to those serving European-based accounts.

Albeit not as easy as it is for large firms with global operations, operational hedging could also work for a startup. The COS (cost of sales) line is often the first place to look. For example, a startup that works with various content partners unique to each customer deployment may try to use U.S.-based content partners when it sells into U.S. customers. And even in the Op.Ex section, a European startup could gradually shift some of its expenses into dollars (such as travel or computer equipment) as its signs more U.S. clients.

Another avenue worth exploring could involve negotiating foreign customer contracts in euros in the first place. This may be a non-starter for some international prospects, but other clients may not object to this. You’ll never know if you don’t ask.

Finally, even commercial banks can provide forex solutions tailored for small firms. One of my portfolio companies uses a well-adapted hedging product from ABN AMRO with great satisfaction. The service essentially allows the firm to lock in an exchange rate at the time of signing a foreign customer contract for a very modest bank fee.

For small companies, no perfectly suited solution to insulating against currency fluctuations exists. However, a combination of the above techniques can help de-risk the impact of foreign exchange volatility on cash flow and allow small firms to focus on what’s most important: signing new customers.