Venture Capital is volatile and often follows the rise and fall of the global economy. In fact, several studies in the past found that the availability of venture capital funding reduces after a crisis.
Why?
During uncertain times, investors shift attention from riskier, new opportunities to more proven, stable investments.
In our post-COVID, neo-AI world, the same uncertainty is trickling down from VCs to startups.
Startup investments are down since Q4 2021
The Wall Street Journal reported that the amount raised in Q4 2022 was 65% lower than the previous year. In fact, the number of VC funds plunged from 620 (Q4 2021) to 226 (Q4 2022).
The data implies that VCs are becoming pickier in funding startups. As hard as it is for startups to raise funds, it’s now even harder.
VCs Are Experiencing Uncertainty
Why the slowdown? According to the WSJ, it’s because…
"Fewer sellers going public through initial public offerings (IPOs), stocks and valuations falling, and interest rates and inflation rising."
Industry Ventures conducted a survey among 117 VC firms to find out what they think about the current conditions of startup fundraising. Their study revealed that 86% of VCs believe the US economy is entering a recessionary period. Meanwhile, 59% believe that “abnormal” market conditions will continue for at least six months.
Startup Founders Have Mixed Feelings
Founders today are divided by optimism and pessimism. Others expect the slowdown in VC funding to continue, particularly in 2023. Meanwhile, others argue that the $290 billion dry powder will re-energize startup funding this year.
We conducted our own small survey of startup founders. Among our respondents, 33% were neutral about the general state of their startup today. 78% claimed the Silicon Valley Bank collapse did not affect their business, and half (48%) were very optimistic about the future of their startup.
Similarly, Crunchbase issued a survey aimed at measuring the state of startups among their reader base.
The study revealed that 65% of respondents believed that an economic downturn “most likely” won’t happen in 2023. However, uncertainty remains looming over the heads of startup founders as 31% of respondents claimed the word “confused” best describes their 2023 outlook.
Respondents in the same Crunchbase survey also revealed that 45% of startups plan to cut costs in 2023.
Big Tech Cost Cuts With Layoffs
Crunchbase reported that the US-based tech workforce laid off almost 200,000 workers in the last 14 months. Mark Zuckerberg claimed to be “flattening” organizational structure in 2023 by making deep cuts to managers.
Economics expert Emre Ozdenoren claimed that in 2020 and 2021 companies faced strong demand as the pandemic pushed work from the office to anywhere. According to him, huge tech companies experimented with new projects while there was cash to spend.
“They had money, they faced some demand, and they needed people. I’m not going to go out and say hiring was fully planned out, but it was definitely the optimal strategy. Going forward, we are going to see much better workforce planning and a need for better people analytics in tech firms.”— Emre Ozdenoren, PhD.
Now profitability is their goal.
In fact, an Industry Ventures study revealed that 55% of VCs expect headcount reductions to have a moderately negative impact on venture valuations.
Founders Look to Alternate Funding
According to a report by the Financial Times, tech startups are exploring alternative financing options as venture capital becomes scarce. Companies are turning to bridge loans, structured equity, convertible notes, and participating bonds to maintain their valuations.
Delivery app Gopuff is one of many startups looking for alternative funding. In March 2022, they received a $1 billion convertible note, following a $1.5 billion convertible note last year. Chris Evdaimon, private companies investor at Bailliee Gifford, told the Financial Times that deals similar to Gopuff are led by existing investors. Their aim is to keep the company’s valuation up.
Startups, in general, have started turning to private debt financing as it has grown 10% annually over the last five years. In 2022 alone, funds secured $208 billion in capital commitments. The trend of private debt financing might continue in the future. Preqin’s investor survey revealed that 63% of institutional investors intend to increase long-term private debt allocations. Meanwhile, only 47% of investors intend to focus on private equity.
Startups are also considering equity crowdfunding as a means to raise capital. The Arora Project reported that equity crowdfunding collectively raised $215 million during the first half of 2022. This surpasses the first half of 2021, which was at $200 million.
A Brighter Future on The Horizon
Despite the uncertain market conditions, the future is looking up for startups that prepare.
In a 2010 article, Harvard Business Review analyzed 4,700 companies during the recessions of 1980, 1990, and 2000. Their study found that while 17% of companies fared very badly (went bankrupt, private, or were acquired) a striking 9% actually flourished and outperformed their competitors by a margin of 10% in sales and profit growth.
Additionally, a recent Bain analysis used data from the Great Recession of 2008 confirmed the HBR study. The top 10% of companies from Bain’s analysis saw their earnings climb steadily even after the recession.
What makes the difference between winning and losing? Preparation.
How to Prepare Your Startup
Based on Harvard Business Review’s analysis, here are some steps startup founders can take to prepare themselves for a short-term downturn in investor capital:
Manage Capital Efficiently
A recession usually brings low sales and less cash for operations. This means that deft financial management should be at a startup’s core priority.
Cut costs beyond headcount
Layoffs are bound to happen during recession. In 2009, 2.1 million Americans were laid off. However, HBR found that companies that thrived focused on operational improvements rather than layoffs.
Digitize Operational Processes
Instead of tightening budgets and playing safe, HBR suggests making digital improvements. Tech investments help cut costs while making startups more efficient. Moreover, companies become more agile to handle uncertain market conditions where change comes at a rapid pace.
At a time when the market is volatile, startups that prepare will emerge stronger than ever.
“Among the companies that stagnated in the aftermath of the Great Recession, few made contingency plans or thought through alternative scenarios. When the downturn hit, they switched to survival mode, making deep cuts and reacting defensively. Many of the companies that merely limp through a recession are slower to recover and never really catch up.”
— Harvard Business Review
