82. 📉Startup Fundraising in a Bear Market

When the economy gets rocky, raising funds for your startup is more challenging. That’s ironic, as many of the best companies were launched during downturns.

In this article, I want to look at how to adapt your fundraising strategy to these times and position your company for maximum success.

Bottom Line Up Front:

• Fundraising will take longer.

• Valuations will be lower.

• Investors will focus more on revenue.

• Investors want to see a longer runway.

Hesitant Investors

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When the market is down, investors get hesitant about making new investments. That is particularly true of the angel investors who typically dominate pre-seed and seed rounds. Angel investors take money directly from their personal investment and retirement accounts. When those accounts are shrinking, taking out cash to back a high-risk startup is psychologically challenging.

Venture Capitalists have a fund, so they don’t feel the same level of pain. They can take advantage of some of the opportunities created by market chaos. However, they still tend to act more conservatively during these times. They often focus on providing follow-on investments to their portfolio companies rather than new ones.

Everyone will look harder, move slower, and negotiate more aggressively.

Lower Valuations

When the market is on fire, many investors chase each quality deal, which drives up the stock price. Near the peak, things can get ridiculous with stratospheric valuations on mediocre companies.

The market has been hot for a long time. Many founders have never known anything different. You might think those valuations are “normal” and find the new valuations hard to take.

From a long-term perspective, valuations are not particularly low now; they have just returned to earth.

With both angels and VC slowing down, the laws of supply and demand are pulling prices down. Fewer investors are chasing roughly the same number of deals as before.

Longer Runway

During the boom times, investors usually wanted to see the round provide about 18 months of runway for the startup. Now I see people pushing for 24 to 36 months before needing to raise another round.

We ask for that because we don’t want you to need to raise again in a bad economy. We hope that things will turn around in a couple of years and that valuations will recover.

Getting that longer runway requires you to either raise more money and suffer more dilution or reduce your planned expenses which may slow your projected growth.

If things are not improving in a year or so, raising your next round might take much longer than expected. Having the extra runway gives you the time you need. The worst outcome is to hit a wall and need to raise money under duress.

Path to Profitability

In case additional funding turns out to be a mirage, develop a plan to achieve profitability in the short term. You don’t need to execute on that immediately. Right after raising a round, you should be focused on growth and execution, but watch your runway closely.

After a year, if you don’t have strong indications from multiple investors, you should start moving to increase revenues and extend your runway. If you can reach profitability, you have infinite time.

Talk About Revenues in Your Pitch

During a bubble, you can often raise money on vanity metrics. I have seen many decks that talk endlessly about the number of users, impressions, interactions, etc.

While those are all good, once the bubble pops, investors want to hear about revenues and business models.

How will you make money, and why will people pay you?

When things are tough, cash is king.

Capital Efficiency

Investors favor capital-efficient companies. Even at the best of times, I worry when I see that a company will need to spend tens of millions of dollars before it can enter the market in any meaningful way. Most pre-seed rounds are under a million dollars, so that means they will need to raise at least one more round before they have any revenues at all. When that happens, early investors often see massive dilution. In a bad economy, that next round might be in doubt, so I would avoid the investment in the first place.

If your model requires high up-front costs, look for ways to cut your capital costs. If you were planning to build a factory to produce your product, can you shift to using a contract manufacturer? That might hurt your profit margins, but it can radically reduce your cost to reach the market. You can always build that factory later once you have proven product/market fit.

Default Alive

Most startups are “default dead” because they will run out of money and fail without infusions of outside cash.

It’s worth considering whether you can reach profitability now, even before raising your current round.

If you become “default alive,” you will have a much stronger negotiating position.

During difficult times, I am far more likely to invest in a company that will use my money to grow than one that needs it to survive.

In the last article, I talked about my experience with Anonymizer during the dot-com crash of 2000. Fortunately, we were lean enough that we could cut and scramble our way to break even, allowing us to continue searching for opportunities until the economy recovered. Many of our competitors had grown too quickly and could not avoid disaster when the money spigot went dry.

Deals are Still Happening

While it might seem impossible to raise money right now, deals are still getting done. As a founder, you must adjust your strategy, update your pitch deck, and reset your expectations. It is a different environment, but the same disruptions that make fundraising more challenging also create many opportunities for agile young companies.

Till next time, ciao!