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02/02/23 | Founders

Raising capital in a down economy

Well, it’s finally official. If you’re an entrepreneur looking to start or grow your company with other people’s money, things are tough, and likely to get tougher.

One lesson I learned raising for my first company, where I say we “skiied the avalanche” of the 1999-2000 tech meltdown, is that as goes public equities, so goes VC and private capital.

The IPO window is most assuredly closed, since CNBC says that IPO deal proceeds plummeted 94% in 2022. The M&A market is holding up but only for those looking for bargains or at least “much more realistic valuations”. Under those conditions, VC’s, Angel Investors, and particularly non-traditional investors, are not looking to make new investments, or to put much money in existing investments.

As goes public equities, so goes VC and private capital

To demonstrate my point, here are just a couple of recent snippets that have appeared in my inbox. From Crunchbase, “North American startup investment fell sharply in the fourth quarter, closing out 2022 witfunding far below the prior year’s record-setting levels. In total, investors put $36.1 billion to work across all stages in Q4, per Crunchbase data. That’s a whopping 63% decline from a year earlier.”

From Pitchbook, “As we head into this new year, the general consensus in the VC world is that funding will be harder to come by and times will be leaner in terms of running a business.” Pitchbook explained one of the big issues: “A large portion of the capital invested in venture deals, especially those in the top end of the market, has come from asset managers such as mutual funds, hedge funds and private equity funds…. However, the participation of nontraditional investors fell sharply through 2022 as valuations in public and private markets diverged.”

That era is over

That’s not to say that VC’s and other investors don’t have cash on hand, many do! But it’s not being deployed as investors wait for those IPO and M&A windows to re-open. I will say, if you’re a later stage company, expect a serious haircut for your next raise. But times may be challenging no matter where you are in your startup journey.

So what should you do?

When I co-founded my first company, DoBox, the NASDAQ stock market was at (then) all time highs, and shortly after we raised our first round, would begin a plunge of over 75% during the following two and a half years. I’ve long said that we “skied the avalanche” and thankfully had a successful exit anyway! As a note, the NASDAQ would not return to the 5000 level until 2015 (yes, 15 years peak to peak!).

Quarterly U.S. Venture Capital Investments 1995-2017

While public markets plunged, private investment from angels, VC’s and PE firms dried up!  And startup fundraising became excruciating. We know entrepreneurs who literally shut the doors and sent unused funds back to investors, because they knew they couldn’t raise follow-on funding.

It’s been a long time since entrepreneurs have had to face an avalanche like the one DoBox lived through, but it appears that it’s time again. Although the 2020 stock market collapse, down roughly 30% in 30 days, offered a V-shape recovery, it is not looking like the 2022-23 bear market will rebound as quickly.

Let’s face it, when you’re heavy into startup mode, it’s tempting to ignore things that seem like externalities (like the public equities markets). However, in this case and at this time, that would be a huge mistake! Why?  Because “as goes public equities so goes private investment”. But why is this the case?

Investors in private companies are getting squeezed on both ends. When a Venture Fund gets commitments from their investors (their LP’s), the commitment is brought into the fund in tranches over the life of the fund.

It’s not like a $500 million fund actually has $500 million sitting in some bank account somewhere, they have a commitment from their investors for the $500 million, but usually only have a portion of those funds actually in hand. And when public equities plummet, as they have been over the last few weeks, often those “commitments” dry up.

Let me repeat that: Yes, indeed, frequent investors in venture capital such as retirement funds, endowments and foundations, do renege on their commitments! So, all of a sudden a $500 million VC fund could be much, much smaller. And much of the remaining money will be reserved for existing portfolio companies, not new investments. VC’s (and entrepreneurs) have been operating in a world of “abundant capital”, but if that’s no longer the case, how does that impact you?

Bonus Tip: Given the current environment, a “Perfect Investor” is an investor who is investing “right now”. That means the investor actually has cash on hand to invest! So be sure to ASK, “do you have cash on hand to invest right now?” (the alternative is that they have to make a capital call for fresh cash!). If they don’t, ask when they expect to be investing in new deals.

Now, on the other end, falling public equity markets also squeeze potential exits. One of my first Directors was a retired VC, and when the last plunge started he said that VC’s would need a year to “fix or kill” all their troubled portfolio companies. Well, it took a lot longer than that! And, given the amount of money that has flowed into startups with no path to profitability during the past few years, it will probably take more than a year to fix this crop too.

If raising from VCs, only a handful of people will tell you the secrets.

So, if history is about to repeat itself, what should the savvy entrepreneur do? 

  • First, make sure you have the magic “path to profitability”, if you don’t have one now, make it a priority to develop one now. 
  • Second, focus on getting 2 years of capital on hand which may involve both that capital raise and slowing your burn rate. 
  • Third, you know my perspective – make sure you Design the Perfect Investor™. Get focused on only those strategic investors who already want what you offer, and then get expert coaching to help you create compelling pitches and docs to get their attention and to look smart and savvy!

Successful companies are started during hard times, but it takes persistence and savvy, so get ready to dig in!

Nicole Davis

Nicole Davis

Nicole Toomey Davis is Co-Founder & CEO of Enclavix, a corporate director (Board Member), serial entrepreneur, innovator, entrepreneur coach and mentor, professional speaker and the President and CEO of AI-software company Enclavix, LLC, and Co-Creator of the VentureWrench Startup Coaching Platform.

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