- Investors are focusing on fundamentals and looking for more extensive business plans.
- The hottest trending startup sectors have changed.
- Founders are considering mergers and acquisitions earlier than ever.
Startup founders and investors are looking at what could be a murky investment outlook over the next few months or quarters. Slowing markets, rising interest rates and turmoil abroad has caused fluctuation in the markets. While the tech sector may continue providing growth opportunity long term, the near term may also be volatile enough that many founders and investors might be forced to take a different path than originally planned.
The path forward may not be easy when considering current burn rates. Nearly half of all VC-backed tech companies will need to fundraise in the next year, according to our State of the Markets report for H1 2022.
Inside VC firms, there are plenty of board meetings going on. In many cases, they’ve stopped investing altogether—global VC funding was down 22% in the second quarter according to our report—to focus on their existing portfolio.
VCs are looking at their slate and may be asking whether their companies are in good operating order and in a good state of being capitalized. They may be considering which companies they have reserves for—and which companies they don’t. Yet not all is negative: VC funds have approximately $269 billion ready to deploy.
Founders are being required to raise funds with clear plans for a longer runway.
So, what does this mean for founders? The conversations with investors have changed. Capital is shifting away from some segments and into others. What could have worked in a pitch meeting in mid-2021 might not work right now. The pace has slowed. Here are five more trends that we’re seeing:
1. The three-year plan is making a comeback.
Founders are being required to raise funds with clear plans for a longer runway. Over the past few years, founders could have gotten away with a 12-to-18-month plan, but today investors are looking to see a longer-term outlook: a 24-to-36-month plan. They might not want to invest unless you can hit milestones within that time period.
Unlike 2021, VCs aren’t trying to win deals at any cost, even if they think the space is trending and that the founder has great potential. Investors are looking for more comprehensive, forward-looking plans that generate user and revenue growth over both the long and short term.
2. Revenue is returning to the fore; growth at any cost is out (for now).
Fundamentals are important to investors again. Revenue plays a key role at the early stage and has become an anchor to an investor’s interests. The converse to this is that growth at any cost is out.
Revenue, especially early revenue, tends to be cheap and frequently the most sustainable form of operating capital. This means that categories with steady, though perhaps not explosive, returns are now looking better than they have in years. So, B2B SaaS companies are back in style.
Likewise, we're also seeing the side effect of direct to consumer (DTC) purchasing during the early stage of the pandemic: the continued rise of e-commerce enablement. Coming out of the pandemic, consumers moved to online purchases with such regularity and frequency that “2.0” or “3.0” versions of companies focused on supply chain management and the return of goods sold online. As a result, e-commerce enablement is a hot, resilient sector with real, durable revenue potential. Even amidst recession debates, recent economic reports have shown that consumer spending continues to chug along.
Startups that might get to a million or two million in revenue in the next year are looking attractive to VCs. Why? Because they might have a much better chance at capitalizing on that company in a year or two than they would with a Web3 firm that might have low revenue for two years. Some investors might still place their long-term bets and hold reserves for Web3 companies that promise to be the future of the internet; however, the Web3 proportion of the average fund could decline potentially.
B2B SaaS companies are back in style.
3. “Domain expert” founders are increasingly valued.
Last year, we saw quite a bit of Web3 terminology slapped on the decks of companies that weren’t Web3-related, because founders thought that improved the likelihood to get a VC meeting. And we saw a lot of companies labeled fintech that weren’t fintechs, for the same reason. If that didn’t work then, it really won’t work now.
What is working right now with VCs is founder authenticity. These are the first-time founders, the bootstrapped founders, the decades-long operators now starting companies using their built-up expertise and fully owned risk. When they enter the world of venture capitalists, they’re putting forward a buttoned up and disciplined plan. They know how to drive a business without venture capital. Hard-earned expertise in certain industries is recognized and valued in investment circles even more now.
Right now, it might be worth scrapping the grand vision—at least for a while— for something more tangible.
4. Modest product-market fits might be just right.
In a down market, finding initial revenue traction, however small, can trump the grand vision that you can’t monetize for another two or three years. Listening to your customers and delivering what they need now may outweigh waiting to find the perfect product market fit that could deliver massive results.
In 2020 and 2021, when cash seemed relatively easy to come by, waiting to perfect that grand vision might have made sense. Right now, it might be worth scrapping the grand vision—at least for a while— for something more tangible.
5. Founders are considering mergers and acquisitions more quickly than they had anticipated.
Because of the market uncertainty we’re facing, we’re hearing about early-stage founders—folks at the pre-series A level—going through mergers and acquisitions (M&A) much earlier than they might have planned. Founders that have previously raised two or three million dollars are now considering acquisitions of $20 or $30 million. This isn’t the home run that VCs typically want from founders. VCs want fund returning exits, and these M&A will likely return early-stage capital (perhaps multiplying it) while doing little to put a dent in fund returns.
If a founder doesn’t know whether or not they can raise another round in the next six months, and their VCs aren’t offering to prevent a round from falling off, an exit offer starts to look pretty good. Some founders that had to fundraise early in the pandemic are now running out of runway and are facing a tough fundraising environment. A modest exit offer could be a great outcome and might provide the freedom to start another company down the line.
The conversations with investors have changed over the past year, even the past months. Being prepared to have those new conversations could go a long way to help you make the best decision for you, your employees and your company.
Running a startup is hard. Visit our Startup Insights for more on what you need to know at different stages of your startup’s early life. And, for the latest trends in the innovation economy, check out our State of the Markets report.