I recently met with a lot of venture capital firms (VCs) during my Grand Tour of the US West coast in October 2022. Here is a summary of what I learned about the funding environment and what VCs are thinking about at the moment.
Early stage is the place to be
There is plenty of money for early stage companies (Seed, Series A and B), but less for follow-on funding for maturing companies (Series C onwards).
This is due to a few factors. Firstly, there is plenty of capital sitting around looking for yield. VC funds raised plenty of money recently, but most of it is as-yet unallocated. There’s an estimated $290 billion in so-called ‘dry-powder’ sitting around.
Secondly, the overall investment mood has changed. Fears of recession (more than actual evidence of potential recession) has caused investors to become less enthusiastic. They’re less accepting of risk, which means yields need to be higher to convince them to part with their cash. Valuations based on, let’s say over exuberant, beliefs in the prospects of marginal businesses are reconsidered. Down rounds abound.
When you’re looking for somewhere to put your money, yield is better if you get in early. The risk is higher that you’ll lose the cash you put into any one deal, but 25 bets of $4 million spreads your risk out more than 4 bets of $25 million. Follow-on funding for a business based on market assumptions that are no longer true is harder to get. This means more investments in early stage companies, and fewer in later stage companies; exactly what we’re seeing.
So the overall volume of funding going to later stage companies has decreased, and there are fewer of them to fund in the first place, because lots of startups fail before then, even in times of irrational exuberance. But because there’s still plenty of investment money available overall, raises are larger at earlier stages than they used to be.
I’ve seen plenty of Seed raises that a few years ago would have been called a Series A. There are even pretty substantial (USD $1 million+) pre-seed raises happening.
Lack of supervision
This results in lots of well-funded early stage companies. More than the VCs can meaningfully supervise. The approach seems to be one of throwing a bunch of companies into the ocean with a few million in funding and then coming back in a year or so to see how many are still afloat. Only the ones that survive will get more funding.
Previously, VCs would provide more assistance to their portfolio companies to at least understand how to stay afloat. “Don’t float face down” kind of advice, at the least. But I’m seeing a lot less support for first-time founders who don’t know anything about, say, marketing. Not that there was a lot there to start with, but there’s even less now.
That’s good news for me, of course, because there are lots of fairly well-funded companies that need my help.
Getting support to grow
The big shift has been in companies that have found some degree of product-market fit and are looking to scale up what they do. This is all about taking what works and standardising and automating it. The rules here seem to have changed substantially from what they were a few years ago.
Previously, the focus was on growth, not on margin. Customer acquisition was the goal, with little focus on the cost of acquisition. So long as you were adding enough new customers, losing a bit on every deal was fine. Not so much any more.
There is still plenty of interest in attempting to buy your way to a monopoly in some areas, of course, but public markets are less willing to replace the smart money with dumb money and buy out those with early positions. That means you can’t have an obviously stupid business model as much, and need at least a plausible sounding story about how you’ll turn a profit.
The edge now goes to companies that understand willingness-to-pay and cost-to-supply and that the former should be higher than the latter. If your startup’s core thesis is that you would transfer investor funds to customers until you acquired a monopoly, then switch to being rentiers and jacking up the price, you’re not going have as easy a time now.
The crunch is coming for all the marginal ideas that aren’t really valuable enough for customers to pay non-subsidised prices for. We’ve seen this cycle before, and will again.
This is also good news for me, because these later stage companies are more desperate to fix their broken methods. Unlike the first-timers, they understand the value of good marketing and are more open to hearing why their positioning or pricing or packaging is wrong. And what to do about it.
I admit I was surprised by how little support was available to startups in most VC portfolios. Not all, but many. There just isn’t the funding available for overhead like a shared-services team in the VC firm that gets deployed to help portfolio companies. VCs are simply too busy to provide the detailed advice needed themselves, and prefer that portfolio companies sort it out themselves using the funding they received. There is some support, but it’s not a systematic thing the way I expected it to be.
There are some exceptions, but the pitches made by VCs to founders that they’ll support you don’t really stand up. If you’re expecting your VC to get stuck in and help you fill gaps in your marketing or HR or operations skills, be prepared to be bitterly disappointed. It’s your company, so it’s your responsibility.
This seems less efficient to me, but it does make a certain amount of sense in that VCs are trying to spread risk across a portfolio and discover who will win based on results. Founders who can’t fix their own gaps in hiring, marketing, engineering, PR, etc. will struggle later on. Better to find this out early.
As a VC, my limited time is best spent on the few companies that are more likely to succeed. I can make them better, rather than spend all my time on remedial education for founders who didn’t at least try to learn it themselves or buy some help with the money I gave them. I mean, that’s what the money was for. Why didn’t you use it?
It’s pretty ruthless, but I can understand the logic. The VCs prefer to let lots of people try and fail rather than having fewer attempts. Fewer attempts means your fund is more likely to miss the big winners that pay for the whole show.
The VCs are after the 1-in-20 massive win (and 19 total losses), not 10 mostly-okay exits. They can focus their energy on deal flow and the winners, not spread thinly across a bunch of what will turn out to be losing bets. That’s always been true, but the market adjustment we’re seeing affects later-stage companies more.
Basically it’s a great time to found a company, but not a great time to scale one. You may not get a funding check in a day the way things were happening 12 months ago, but there’s plenty of money there for a reasonable pitch to the right VC. Smart founders can do a lot with a few million in seed funding if they’re careful about burn rates.
And I’m only too happy to help you make good use of that money to set you up for success when you go for your A- or B-round.