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Under the current macroeconomic climate, startups and operators are preparing to weather the storm ahead.
To best empower finance leaders and founders, Abacum’s CEO, Julio Martinez, sat down with Reid Christian at CRV, and Peter Specht at Creandum, to gain an inside perspective on how startups should think about funding in the next coming months.
Navigating through an economic downturn can be intimidating, especially for any scaling startup. The changes in the macroeconomic environment have not only impacted venture capital funding, but it is also shifting the way startups plan for the future.
Julio: Before we get started, I would love to talk about your backgrounds. How did you both get involved in the world of venture investing?
Reid: I entered the VC world about 10 years ago, after having worked in Investment Banking and making the switch to a startup. Working with early stage founders and helping build the SaaS companies of the future is what drew me into the industry and I haven’t looked back since.
Peter: My personal journey into venture started directly after my studies when I was working at two Rocket Internet ventures which sparked my interest in the startup ecosystem. After gaining experience with private equity clients at BCG, I realized that I preferred working with early stage startups where I could help founders build their companies from the ground up.
Julio: Let’s delve into the current market conditions. What are the triggers that have caused this hit in public markets and how are these drivers now influencing the private sector?
Peter: We are currently approaching the 3rd largest downturn of NASDAQ in the past two decades. So why did this happen? In response to COVID, the government and central banks have gone the path of “easing” the economy by creating a generous monetary policy where they have printed excess money. This resulted in high prices across the board.This also resulted in over-valued multiples.
Now that we’ve come to the end of the stimulus, central banks are trying to regain control over inflation, but are struggling to do so now that they are dealing with higher prices and a potential recession. While this effect has been felt in the public market, we are now seeing its effects sweeping through private entities as well. Valuations went down almost 50% in the private market and we are seeing that these companies are having a harder time gaining funding during growth stages.
Julio: Do you think these conversations over the current state of the market are the symptoms of an overreaction, or is it the new normal?
Reid: I am not convinced that this is the new normal, there is still a lot to be determined. We still have lingering effects of the pandemic that has caused supply chain issues, an emerging war, political instability, and other ulterior factors that are causing economic shifts. While it is true that we have seen changes in tech company valuations, we haven’t witnessed any adjustments to enterprise buying patterns or a tightening of budgets just yet.
These are the changes that we have to look out for since these changes would lead to a new normal. There is still a big question mark over the future of our economy and it is too soon to make assumptions. The next six to nine months will bring more clarity on what we can expect and how we will have to adjust.
Julio: Do you think we are entering a full-fledged recession that is going to impact economic growth? Do you envision a V-shaped or U-shaped longer recovery period?
Reid: Without a doubt these effects we are facing now will ripple throughout the next few years. It is still difficult to hear people talking about this approaching recession, see unemployment increase, and a war for talent hitting record levels, both high and low. It doesn’t feel like we are in a recession.
Peter: Everyone is hoping that the economic recovery of today will mirror that of COVID’s. We saw a v-shape recovery in the tech startup space after the pandemic hit. However, the fundamentals this time around are very different when looking from a macro perspective. The clear assumption is that it will look different this time around and will likely parallel the recession that occurred in 2008.
Julio: If we look at seed and series A companies, what have you seen in terms of impact from a European and US perspective?
Peter (European perspective): In the very early stages, the seed round is the stage where these effects are felt the least, but it’s starting to arrive. What we are seeing now is that the extraordinarily high rounds that were once commonplace are now trickling in slower and many investors are asking how they can deliver on these evaluations for the next rounds.
When considering today’s market conditions, companies must show much more metrics compared to previous years. The valuations of startup funding have clearly been impacted. Aside from that, VCs feel that the market is still active. We continue to see very interesting seed rounds and founders emerging. What’s important for founders to remember is that it’s all about building the product and finding your product market fit.
Reid (US perspective): In the US we have seen a slow down not in deal volume but in the timeline itself. People for years have talked about how “founder friendly” the market is. The power dynamic shifted from the VCs to the Founders where they had the power to set their own desired terms. In the past 18 months, however, we are starting to see a shift towards an “employee friendly” market, meaning the power is moving further from the founders and even further away from the VCs. I think we will see that founders will have to look closely at their teams and have better access to top talent and tightening budgets around headcount. VCs are now taking their time on valuations while we go through this rebalancing of power.
Julio: What kind of growth are you seeing in the later stages? In particular, let’s talk about the differences between prioritizing efficiency vs. pure growth? How has this impacted metrics?
Reid: In the public markets there are market makers that buy, sell, and create liquidity. The private markets traditionally operate differently. However, over the past few months, we are now seeing some crossover funds that have come into private investing as well as large PE-style funds that have been largely the market makers in the series C, D, E, and late stage rounds. Typically these investors were more likely to invest than not or even compete for those higher rounds.
Today, that has pulled back almost 90%. These funds either stopped investing altogether or are investing much less amounts and being more cautious. As a result, growth investing is almost frozen. When compared to early stages like series A, these investments have slowed maybe 20%, but there is still a lot of movement among these startups. As a result, many companies have just decided not to raise right now, which leaves only the companies that need to raise. All these factors come together to create far less deal velocity and much less announced rounds as we start approaching Q3.
Julio: Let’s talk about price sensitivity. Have you guys changed your criteria when in the decision-making process or when you are evaluating opportunities?
Peter: As an early stage investor, we are very aware of the trickle down effect that is occurring right now. Typically what we look for is that startups are able to do a 3x from one round to the next in terms of valuation. Last year’s market saw much steeper jumps between stages. However, this is more of a guideline on the value companies should strive to create between rounds. Given these parameters, companies need to see what a healthy valuation is for them to raise on considering today’s market so they can set reasonable uplift until the next round.
While these funding rounds may seem much lower, it’s also important to note that last year was an exception to the norm and showcased extraordinary levels of funding unlike any other year. While it is not impossible for a startup to receive these amounts of funding, most VCs are now treading with caution and are more careful who they choose to invest in.
Julio: Where should founders focus? What advice would you give founders who are trying to create an investable startup in this period? What are the metrics you want to see and what levels of growth are you expecting in this economic environment?
Peter: As an investor, our expectations of what we are looking for have not changed. We still look for attractive growth,a split LTV/CAC ratio, net negative churn, and so forth. The metrics that have changed are the metrics around efficiency. The burn multiple is being closely watched, as well as payback times or magic number calculations. My advice to founders is to prioritize these numbers and adjust benchmarks to reflect the current market conditions. Over the next 6 to 12 months we will start to see what these new growth rates are.
Reid: It’s also important to note that startups are competing against other startups for venture dollars. We have to account for each company being so different from one another and consider their different business models. I think 100% year-over-year growth should be a bare minimum if you are looking to attract VC funding.
The best thing a founder can do right now is to really know their business and their numbers. It is absolutely critical to understand their growth levels and efficiency so they can have a deep understanding of the inner workings of their company. Investors want to make sure customers are using your products, what the usage statistics are, and so forth. Keep in mind when looking for funding that investors will have a much more analytical eye when making decisions. Founders really have to prepare and study their businesses like never before.
It is clear that founders are under more pressure than ever before. However, with the right preparation and insights, any startup leader will be able to navigate the storms ahead and make it out on the other side. By adjusting expectations and benchmarks to match these new business environments, startups will better be able to position themselves for success even during uncertain times.
Abacum helps many organizations step up their game and navigate the current market conditions by transforming Finance leaders into heroes – with the help of a flexible, collaborative solution, Finance teams are able to connect with stakeholders across their organization to surface insights, drive execution and enable decision-making.
To find out more about how we can also help your team prepare for the storm ahead, book a consultation with one of our specialists.
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