Building a startup has always been an incredibly tough job in all market conditions
It seems there is a competition going on online to give founders the most pessimistic advice. A quick scroll on LinkedIn or Twitter would cause even the most optimistic CEO to shut down their company and run for the hills. Such blatant doom-mongering may be good for views and likes, but it’s nonsense.
To begin with, the venture capital market cannot be treated as a homogeneous mass. Advice to founders raising a series C round should be very different from founders raising a seed or series A round. Yet the online commentary rarely makes that critical distinction and reverts to overly negative, unhelpful generalizations.
It is also not the first time that we have experienced a recession. Many founders and investors will not have lived through the dotcom bubble or the global financial crisis. For those who have, the current conditions feel familiar and not unprecedented. Like all bleak economic times, there are challenges and risks, but also opportunities.
For founders who are in the early stages of establishing a venture-backed startup – that is, before and including raising Series A – there are reasons to be cautiously optimistic.
Seed rounds take place
Most commentary on the overall health of the venture capital financing market looks at a short time frame. The headlines are announcing that venture capital funding will be lower in 2022 than in 2021. If we dig deeper, there are good reasons not to be too alarmed.
First, early stage financing is least affected and still totaled $34 billion globally in the third quarter of 2022. The decline from 2021 of 25% quarter-on-quarter and 39% year-over-year is a somewhat pointless comparison. Venture finance could not continue to grow exponentially and this correction was only a matter of time. Moreover, and to make it clear, billions of dollars are at stake still going to start-up companies around the world – capital supply will naturally ebb and flow.
Second, looking at venture capital funding in the UK since 2013, the long-term trend is up, with 2021 an anomaly. If we compare 2022 to all years before 2021, funding numbers are still relatively healthy. And this makes sense. As an investor in the (pre-)seed phase, exits are so many years away that the prevailing macroeconomic conditions have relatively little influence on decision-making.
The danger for founders is to create expectations in the belief that 2021 was a normal year and that what was then needed to raise is now the same. It has becoming harder to raise due to reduced capital (versus 2021) and recalibrated risk appetite, but founders are still closing seed rounds. The market has changed but remains open.
Series A funds are active
For Series A funds, 2021 has been a challenging time. Valuations were sky-high and fundraising processes were incredibly fast, making due diligence and robust decision-making a challenge. For many funds without a premium brand, access to the best companies has been a struggle. Everything will be back to normal in 2022.
Looking back at the comparison to 2021, Series A funding is the least affected in 2022 — down just 23% year-over-year. This reflects the fact that many strong companies raised and held money to invest in them.
The recalibration at Serie A affects founders in a number of ways.
Most notably, valuations have reached their highest level in 2021. Huge rounds at high valuations that were at the forefront in 2021 now look exuberant at best or rushed at worst. They also cause headaches for founders struggling to grow into them and raise their next round on tasty terms. These days it might feel a bit negative to give away more of your business for less money compared to last year but reasonably raising the right amount of money you need for sensible pre-boom dilution worked and will continue to work in the future.
The type of funds in the Series A market also continues to evolve. Multi-stage funds are cautious, busy looking after their later-stage portfolio companies, with some dipping their toes in with seed checks to stay active and relevant (and justify their management fees to LPs). Podium specialists are enjoying their moment in the sun – able to seize opportunities they may have missed in 2021. Processes have lengthened and are taking longer than before as funds dig deep into every opportunity, keen to avoid sub-optimal decisions. to make. It’s painstaking for founders, but results in more lasting early relationships with investors.
Expectations at Series A have also been reset to pre-2021 levels. Gone are the days of preemptive rounds where companies only have a few hundred thousand dollars in revenue. Metrics that founders must meet to have a realistic shot at a Series A funding round are fluid, but the now-familiar SaaS funding napkin is a handy guide.
Lower valuations, longer processes and more accuracy around the required metrics are nothing like them big news to founders, but they represent a long overdue return to reality. They do not mean the market is closed. As with seed (and pre-seed), funding levels at Series A remain robust by historical standards and many founders continue to close out rounds.
Time works in your favor
Early stage founders will be looking for growth funding in a few years – from series B onwards. Growth rounds are tough today and no one knows when the current cycle will turn. In two or three years, however, we will probably be back on the rise, with capital and risk appetite returning as public markets thaw. Nothing is guaranteed, but founders who start now or travel early are in a much better position than those who unfortunately ended up in the eye of the storm.
Founders who read advice to reduce their workforce, drastically cut marketing budgets, strive for default living or close their business should think carefully about whether that advice is relevant and proportionate. In these challenging times, many commentators use worst-case scenarios to generate clicks, or extrapolate their individual experiences to make assumptions about the entire venture capital market.
Being a founder of an early stage company has always been difficult. It will be more difficult in 2022 than in 2021, but not materially harder than in recent decades. The right approach is cautious optimism, shutting out the noise, taking advice from a small number of people you trust, and not letting fear dictate your actions.
