The world has yet to decide if we're heading towards a soft(ish) landing in a troubled global economy. At the moment, the macroeconomic signs have mood swings, and we will likely still have some rough weather ahead in 2023. No interest rate cuts in sight, valuations have dropped, and the private equity and venture capital managers slowed down their deployment pace; what is next for founders?
In 2022 US Venture funding was down 37% compared to 2021 but still up from 2020 (CB Insights). Venture funding in Southeast Asia soared in 2021 up to 25B in investments and was down in 2022 (still up from 2020). In this climate, founders are facing more challenging choices. Do I focus on profitability or continue to increase market share aggressively? The market seemed to have made a choice for founders. 2022 was a slow year for tech IPOs globally. According to EY, IPO deal proceeds plummeted to 94%. I wouldn't attribute the declining IPO market to the profitability of tech startups, but it has played a role in the overall sentiment. What should you do as a mid or late-stage startup? Raise capital in this challenging environment? Give in on your valuation and raise at a lower price? Or hold it out as long as possible without returning to market?
Understanding some of the dynamics of this year's macroeconomics is helpful for founders. Investors say good companies can always raise new funds, which is true, but this year seems increasingly challenging. Startups across the board started increasing their runway, mainly through cost-cutting and, in some cases, slowing down growth. How much can you slow down before it impacts the upcoming fundraise? Is the path to profitability going to be the norm moving forward? In my opinion, there are three major takeaways from the current environment:
Cash is King. In these times, cash is king, and money in the bank is vital. Whether startups are raising funds to extend their runway, prepare for M&A or expand their geographical footprint, now is the best time to take on new capital if you can raise funds. If the outcome of the fundraise is a lower or flat valuation, there is no need to be too concerned about it. Fundraising in a problematic environment shows the business's quality and prepares the company for increased growth when macroeconomic times are better. It shouldn't be underestimated how much of a head start a startup has when it has both capital (with the ability to acquire potentially) and the right timing to grow.
Growth versus profitability. Founders are concerned that focusing on profitability in the short term might hurt their growth. I prefer not to see it as a choice of two evils. At the very early stage (seed to series B), profitability is not a topic because the startup is still proving the business and working out different ways of its growth. Post series B, the conversation about when the company should become profitable will be more prevalent. Late-stage investors have shifted the conversation and want to see controlled burn rates, a clear path toward profitability, and seniority in leadership teams. Companies focusing on growth at all costs and heavily leaning on subsidized growth at the late stage will see a more difficult fundraising landscape.
A shifted venture landscape. The overall pace of venture capital deployment has slowed; there are no signs it will pick up soon. Limited partners, private equity, and venture capital funds are looking at the first six months of 2023 to understand how heavy or mild the economic winds will be. Equally, the industry is looking for insights from the FYE 2022 financial statements of companies and fund managers. How much have valuations corrected? What is the average runway of portfolio companies? How much dry powder are funds looking to deploy in 2023? The answers to these questions will help the industry adjust its strategy for the second half of 2023 and early 2024. These times do offer opportunities for founders. Limited partners, family offices, and late-stage investors seek access to co-investments in series B and later-stage startups.
Although fundraising timelines have been extended and the overall deal pace is slower, it is still a good time to engage with investors. The earlier, the better, even if the startup is not fundraising.
A few things to consider for founders:
If you see opportunity to acquire companies to increase revenues, now is the time.
The second half of 2023 will be crucial for companies who raised in 2021 and are looking to come back to market. Start conversations with investors today.
Assume fundraising timelines will extend and investor want more proof points. Growth, albeit important, is not the only metric investors will look for.
Don't just optimize for valuation. Optimize to get the business through 2023, streamline and be ready for growth in 2024.
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