The Tech Slowdown is Here — But Startups Can Still Raise Cash, VCs Say

In mid-May, startup accelerator Y Combinator sent a blunt warning to its founders: “No one can predict how bad the economy will get, but things don’t look good.”

One month later, things aren’t looking good at all. The champagne flow of venture capital dollars has slowed to a trickle, and the funding scene no longer resembles a gala hosted at Jay Gatsby’s West Egg estate. Already, startups have begun dishing out layoff notices to thousands of workers in a desperate attempt to conserve cash, reduce their burn rates and extend runway.

“I think a lot of companies got funding last year on a whim,” explained Jesse Wedler, a general partner at Google’s independent growth fund CapitalG. “Now, we're reverting back to the historical approach of being more disciplined and saying, ‘let's go fund high competence and efficient growth.’”

But the roaring 20s aren’t over just yet. The funding bar is higher now, but investors say startup founders can still raise VC money--and plenty of it.

What’s going on with VC funding?

This shift toward austerity feels sudden, but the overheating VC market was bound to cool off. In 2021, VC-backed companies in the U.S. raised $330 billion, nearly double the previous record of $167 billion raised in 2020, per private markets data platform PitchBook. Median early stage valuations also jumped 50% year-over-year to $45 million in 2021, underlining “the tsunami of capital flowing into the venture industry,” as PitchBook put it.

Though private markets tend to avoid public markets’ knee-jerk reactions to macro events, the vibes are certainly off. Recession chatter is spreading thanks to inflation rates north of 8%, a war in Ukraine, crashing stocks and layoffs in tech and other sectors, including real estate.

So, while VC firms raise funds months or years before doling them out to startups, the economy’s uncertain near-future may have them guarding their pennies more closely. Founders looking to fundraise have license to worry, but they shouldn’t give up hope. After all, investors have hoarded more than 3 years’ worth of dry powder.

“Even in bad times, good businesses are fundable and private market investing continues,” said Blair Silverberg, a former investor-turned-founder of a platform called Hum Capital that helps other startups present audited financial data to investors looking for their next big portfolio find. His company hinges upon the idea that data can help entrepreneurs clinch favorable term sheets and reduce the “who you know” ways of the VC world.

“We’ll most likely start to see that the current conditions favor the top percentile of high-performing companies, whereas companies with volatile or non-recurring revenue will be pushed to accept funding at lower valuations,” Silverberg said.

Valuations tumble

Founders who manage to raise funding right now must prove their worth--and be willing to accept significantly lower valuations than they might’ve seen a year or two ago.

“Companies need to accomplish more to garner [their valuations]--that means extending runway,” said Isabelle Phelps, a partner at New York City-based early stage venture firm Lerer Hippeau. Scores of promising startups like crypto platform BlockFi and investing app Wealthsimple have recently sliced payroll costs to do just that.

Many factors are piling onto today’s valuation pullback, including rising interest rates, frequent supply chain issues and inflation--leading investors to shy away from riskier investments like venture capital. And startups that have commanded higher private market valuations in recent years after raising mega-rounds of funding now find themselves in the tough position of having to prove those valuations.

Public market tumult is also dragging down valuations, since many investors value startups by comparing the investment opportunity to similar public companies. Simultaneously, startup revenues are getting hit as people rethink budgets and prepare for a potential recession, explained Kyle Harrison, a general partner at founder-focused VC firm Contrary.

“It’s kind of a rock and a hard place for a lot of companies,” Harrison said.

Early stage loses its edge

Here’s some investing irony: while it’s more difficult for first-time founders to break into the VC world during a conservative period, early-stage startups are also more likely to get funding in a recession than their late-stage counterparts, because they are further removed from an exit into public markets.

Harrison maintains that some early stage deals are “definitely” still getting done, and said his firm has invested in about a dozen deals across stages in recent months. But the venture pause is affecting even the tiniest rounds--angel, pre-seed and seed rounds that can range from $500,000 to a few million.

“Every stage of company is being impacted, in one way or another,” explained Harrison. “But the rounds that are most likely to just not get done are fairly later stage rounds where the company doesn't want to raise unless they can meet or exceed their previous valuation…investors don't want to invest in those valuations because they are based on a very different macroeconomic market.”

Part of the reason for the funding slowdown affecting even early-stage companies is that VCs are waiting to see just how bad the market gets. “Pre-seed/seed investors are moving slowly on new investments. I see this with coinvestors in rounds we're diligencing, in conversations with other VCs and from our portfolio companies,” Maren Bannon, a general partner at January Ventures, tweeted last week. “The reason? Many VCs are waiting to see when we hit bottom.”

Show me the money!

No surprise here: Investors want returns. As their risk appetite for moonshot ideas wanes, solid financials are one key to securing funding right now.

A startup’s “customer lifetime value to customer acquisition cost” ratio (commonly known as LTV/CAC) is king when it comes to raising additional capital, according to Hum Capital CEO Silverberg. VCs use this metric to determine if a startup’s marketing and sales efforts are actually creating long-term value--and, ultimately, if writing another check could result in a positive ROI, he said.

“Confidence in your company's data can have major implications on future valuation and deal terms when raising capital,” Silverberg emphasized. “Investors may be tightening their belts overall, but companies with strong performance indicators will be poised to rise above the pack amid the volatility.”

Financials are exceedingly important right now, but investors say efficiency and discipline are also key.

“Founders were, for the last couple of years, encouraged by the investing community to prioritize growth and growth at all costs,” explained CapitalG’s Wedler, whose late-stage deal portfolio includes Airbnb, UiPath and Notarize (a digital notary app that recently laid off 25% of its workforce). “Now, there's a focus on efficiency and efficient growth.”

When meeting with investors, startup leaders should have clear perspectives on questions like, “What is our path to building a big business? And how are we going to do that efficiently?’” Wedler added.

Words of wisdom

Investors are hesitant to predict how long this funding slowdown will last, but they maintain that smart teams and sound startups can still thrive.

Contrary’s Harrison advises founders to increase the volume of conversations they’re having with investors. A few months ago, founders might’ve had 50 fundraising conversations that yielded 15 interested investors, but now they might only find one or two promising connections from that same group, he said.

“There are a lot of investors out there who have dollars to deploy, it’s just harder now,” he added.

If a typical venture round isn’t in the cards, Lerer Hippeau’s Phelps suggests cash-strapped startups explore other forms of financing like venture debt.

Harrison also echoes Wedler’s call for efficiency. “You might not be able to invest in all of the adjacent product areas that you've been excited about,” he emphasized. “But you just want to nail your core business.”

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