Erik Ross is the Head of Mergers and Acquisitions, Venture Capital at Nationwide, a division of insurance and financial services company Nationwide, which seeks to invest in founders and startups that are shaping the future of insurance and financial services. Erik was interviewed by Michael Fiedel, a Managing Director at InsurTech Ohio and Co-Founder at PolicyFly, Inc.
Erik, what market factors in insurance do you follow most closely that guide your perspective on where the economy within our industry is going?
“Given the recession backdrop, market volatility, high inflation, supply chain disruptions from the COVID-19 pandemic, war in Ukraine, climate change, worker shortages slowing but continue, higher wages, rising medical expenses, vehicles are now computers with wheels, etc., we're in a situation unlike any I've experienced in my lifetime, and I'm old enough to remember the 70s oil crisis, Black Monday, the dotcom bubble while in a startup and working at a global bank during the Great Recession. We're really operating in unknown territory with no clear answers. In July, S&P (Standard & Poor) indicated that P&C (Property & Casualty) industry combined ratios could be above 100 for 2022 - that would be the first time since 2017. As an example of the impact of these factors, auto insurer loss costs have dramatically increased in quarter two given the auto industry has been particularly hit hard by both inflation and supply chain challenges (labor costs, part shortages, inflation, etc). Insurers are going to be focusing on expenses in the second half of 2022 given these trends aren’t going away. Similarly, we’re seeing elongated sales cycles in many of our portfolio companies that focus on large enterprises as a target segment, and we expect that trend to continue for the remainder of the year as companies look to shore up expenses with price and premium increases.”
Has the shifting economic climate changed Nationwide’s M&A or venture appetite?
“From a venture perspective, the environment hasn’t changed our strategies markedly as we’re on historical deal pace in 2022 in both new and portfolio follow-ons, and we are actively looking to invest in startups related to our thesis areas. We're maintaining discipline, focusing on deal flow in our thematic focus areas. To quote Jerry Nuemann, we’re looking for companies that ‘are solving a problem that causes the customer a lot of pain and that can build the right solution given time and money’ – highly recommend his blog Reaction Wheel by the way. Brian Anderson did a great job outlining our approach in his discussion with you as well.
From a M&A (Mergers and Acquisition) perspective, we continue to look at early-stage tech companies for acquisition opportunities that can provide a unique capability to extend or accelerate one of our business units. This process has essentially turned into a build vs. buy decision process. We consider internal costs, execution risk, time to implement and balance that view against the technology the startup has developed, the talent in the team, the ability to keep the team intact post-transaction and what the company and investors are looking for an exit. We expect to see more and more of these types of situations over the next 12-18 months, like the recently announced LexisNexis Risk Solutions acquisition of Flyreel which looks to be a great outcome for all parties.”
How do you see the economy otherwise affecting startups?
“It's a great question without a simple answer because it depends on the specific company, where they play in the value chain, integration costs, complexity of implementation, stage of the company, where they’re at in the sales cycle and what the ROI (Return on Investment) is for the buyer.
We are seeing late-stage companies that were looking to raise large rounds postpone their raise and instead look to insiders to bridge the company by either extending previous rounds or using convertible notes. Terms have shifted from entrepreneurs to capital, and only some companies have fully digested this market shift. Investors are looking at the neocarrier public comps and are pushing companies on fundamental disciplines and a path to profitability as the private markets have shifted from growth at all costs to growth, gross margin and operating runway. Companies are cutting expenses but nowhere near the extent they were at the beginning of the pandemic. Companies that were considering IPOs (Initial Public Offering) have now postponed the process for 18-36 months given the markdowns in comparables. There’s also an investor education effort broadly to inform potential public investors about operational differences between true software technology companies like Guidewire or those that can enable incumbents vs the disruptive risk capital bearing neocarriers.
We have seen some valuation compression in early stage, and it’s nice to get back to a deal pace that is closer to normal timing with a process driven by due diligence as opposed to the pre-emptive rounds the market experienced last year where a potential investor was asked to commit and close a deal within a few days with no data room. Seed deals seem to have not yet been impacted by capital markets volatility and series A seems strong as well.
In general, the current environment can potentially accelerate a company’s value proposition. If your company is deep in the sales cycle, has light implementation costs, a budget in place to support the project and a solution that can provide operational efficiencies and help alleviate current cost pressures, the company is likely to see tailwinds in this environment as carriers are looking for immediate efficiencies. If you’re at the top of the sales funnel, you need a gut check on the target customers’ priorities given the economic backdrop. Where does your solution sit in the priority stack? Is there a budget? Is there a team identified to execute the project, or are resources being pulled to other areas? If budgets are being cut and resources redirected, the sales cycle is going to elongate. The question then becomes does your company have enough capital to make it through the cycle, are you hitting appropriate de-risking milestones for a subsequent capital raise and do the current investors still believe in the company, etc. Survival is the ultimate metric. These are all basic items, so I’m not offering any epiphanies - just discipline, and that’s hard to learn if it wasn’t there before.”
When venture capital becomes tighter, does it present an opportunity for insurance industry incumbents?
“I’ll provide several answers again to this question depending on the role. From an investor perspective, we are very lucky to be a CVC (Corporate Venture Capital) and a mutual company. We have senior leaders and a board that are focused on the long-term success of Nationwide, our partners and our members. Nationwide Ventures doesn’t have to worry about traditional funding/harvesting cycles. From that perspective, we can be patient with portfolio companies and support them through challenges like the pandemic and economic cycles where we believe in the team and the vision, but we know it may take a bit longer for the business to develop. In the right situation, we also can help provide commercial opportunities by facilitating relationships with Nationwide.
While we are fortunate in these aspects, we also worry about adverse selection, so we must remain disciplined. I am very fortunate to work with a great team that is intellectually honest.
From a M&A point-of-view, incumbents can absolutely look at these economic conditions as opportunities to acquire capabilities, talent and technology. Western & Southern’s acquisition of Fabric is another great example of how an incumbent can utilize this strategy. M&A teams working with their business units, technology and corporate strategy teams can identify areas where a startup’s technology/solution can tuck in nicely to the strategy and accelerate objectives and outcomes. Relationships matter in these instances of early-stage companies looking for exits, so it’s helpful if there’s an established relationship with the company, a great cultural fit and that the product/engineering teams can stay engaged post-transaction – this is key from our view. You need the team that built the solution to remain intact since they are the only ones that know the codebase, where the skeletons are hidden, what needs to be rebuilt/refactored, embedded technical debt, etc. In my opinion, it’s a mistake to buy the technology without the team that created it. As I mentioned, we’ve looked at several of these types of opportunities already, and we expect to see similar deals announced throughout the remainder of the year and into 2023.”