A Field Guide for Startups Raising Venture Capital in 2023

Startup Showdown

During a recent webinar with eMerge Startup Showdown competitors, we fielded questions about how founders can navigate VC relationships as they raise capital for their early-stage companies. In this post, we share highlights from that conversation, including what venture capitalists want to see, what's happening in the marketplace, and how to fundraise, build, and scale successfully.  

What VCs Want from Founders Raising Capital

How does the VC business work?  

VC is more than a team with a big fund of capital that they deploy to founders. Venture capitalists have bosses - the investors (you'll see them referred to as "limited partners" or "LPs"). We raise money from LPs and then invest it in exceptional founders in high-growth categories. The decision to bring a company into the portfolio takes massive research, data analysis, and relationship-building.

VCs return the money we've invested in each portfolio company over a period of time ‚Äì typically seven to 10 years. That is when our investors earn their money back, with interest. The goal and intent are to ensure they earn at least 3.5 to 4 times their money.    

What is the risk and reward balance in VC, and why should founders care?  

Data from over 20,000 deals over ten years shows a 50-65% chance that an investment will not return the money invested. Put differently, there's a 50-65% chance that the startup will fail. That's a lot of risk for founders and investors.

That high risk of failure is why investors talk about outcomes. If approximately half of all companies in a portfolio do not create a return on the money invested in them, then each company with a successful exit has to return 8x. Or if only a third of the companies in a portfolio succeed, the ones that do need to return 12x. The bottom line is that successful venture investing takes strong outcomes. It's why between investment and exit, a good VC will work diligently alongside founders to provide them with support and resources beyond the capital. It helps them succeed and accelerate their progress ‚Äì which is good for everyone.    

What are VCs and investors looking for from startups?  

Think about how you know that you have a viable business. Like you, investors want to understand the problem you're solving and know that the problem is real. Prove that the market is compelling and ready for what you are offering. Confirm that you understand the problem and solution, as well as possible hurdles and how you'll address them. And show that you have an organization purpose-built to address those issues. You can answer all these questions by showing your traction, data, and team.      

what VCs are looking for from founders

What are the skills that VCs value most in teams?  

  • Self-awareness. Know what is happening in your business and be honest about what's happening.  
  • Grit. Everyone has heard how important this trait is, but I'll second that here.  
  • Tenacity. Stay with the business long enough to find product market fit. Growth rarely goes 'up and to the right' immediately. There are so many pivots and bumps along the way. Great teams have what it takes to endure difficulty.  

Does a startup need to be an LLC or an Inc to receive investment?  

Many investors need to be able to invest in an incorporated business. But don't rush into it just to apply for funding. An investor will talk you through the structure that makes the most sense for where to start and if/how you convert over time. Do what is best for your company and team.    

What can a pre-revenue company do to make its business model more attractive?  

Unless you're talking to an investor who does not invest in pre-revenue businesses, there are a lot of proof points you can show without showing revenue. For example, you can share user engagement, time in an app, or customer feedback. Those things tell investors you have a market.    

What happens if I have disengaged investors?  

Consider whether your incentives need to be aligned. Are you headed for a $500 Million outcome when the fund that invested in you needs $5 or $10 Billion? Investors have limited time, and they have to allocate it accordingly. Be smart about whom you target as an investor if you can.      

Raising Venture Capital in the Current Investment Market  

How and why has it become so hard to raise VC money?  

In 2021, we heard about 100x and 200X revenue multiples for companies with minimal traction. Now, they're back to five and ten. There are two main points to consider here:    

  1. Over the past ten years, money has been relatively cheap. In fact, it's been close to 0% for a very long time. Right before COVID-19 hit, the yield started to tick up. During the pandemic, it came down again. If you're selling equity (i.e., taking money from investors in exchange for a share in your company) when money is cheap, you'll get more.  
  3. The supply of money has skyrocketed since 2010. If you have something that's already really cheap (money), and then you flood the market with it, it gets even cheaper. That confluence drives up the value of your startup.  

After about ten years of extremely low interest rates, things slowly ticked up. It shocked the economy. COVID exacerbated the situation. The result was valuation craziness. Everything in the market tripled. Companies trading at 4x were suddenly at 10 to 12x due entirely to outside forces.        

Cheap money and more money means crazy VC valuations
What caused the crazy funding rate shift?  

 If you plot company KPIs over the last ten years or so, you see little change in top, median, and bottom quartile results. However, valuation multiples changed meaningfully over the two years since the onset of COVID. With entry valuations increasing 2.5x-5x across the board, revenue performance expectations for the same return to investors also increased 2.5x-5x. These are massive jumps, and they impact the exit value needed by companies. Essentially, more (and more significant) outcomes are necessary for a fund to hit its return goals.  

Venture Capital investment market trend charts

What is happening with private capital investment?  

You may have heard conversations about needing Decacorn-type outcomes. A $200 million exit that earned the founders $50 Million becomes a disaster for a Billion-dollar fund because the exit, while sizeable, only returned 1.5 or 2x. That's a significant consideration for private capital investors.    

Especially as valuations of private market-funded companies have gone up (similar to those in the public market), investments have slowed. Funds haven't been willing to pay as much. It's created some fear (especially in 2020-2022 fund vintages that may have a greater proportion of investments done at historically high prices), but people are still investing.      

Over the past six months, the market has started to normalize. Venture investors are sitting on record amounts of dry powder (capital raised but not deployed). In fact, at the start of 2023, there was $290 Billion in dry powder. That is a lot of money to deploy to high-growth startups. The considerations are that the time between investment and exit might be longer. The valuation might be slightly lower. But capital will be invested.      

How to Succeed as a Startup  

  • Be realistic. If public markets are down 60 to 70%, your valuation is probably down two, and that's not your fault. But be smart with money and build for the long term.  
  • Expect diligence. When people were playing fast and loose with cash, a lot of diligence went out the window. And you've seen the fallouts from that behavior. Those days are gone. Know your data, organize how you present it, acknowledge your gaps, and take your time because the diligence process will take longer.  
  • Try not to take things personally. Investors pass on founders for so many reasons. Some funds are struggling right now, just like some startups are. And the big public markdown stories (like Stripe) are scaring some VCs.  
  • Consider basic finance. A dollar today is worth more than a dollar tomorrow. In a market where valuations could get worse before they get better, it's wise to take money when you can.  
  • Optimize and cut expenses. Unless you have tremendous product market fit and see a foolproof opportunity ahead of you, be as lean as you can.  
  • Be ready to be opportunistic. You may have dream executives or employees you want to hire. You may want to acquire a competitor. In the past, they might have been too expensive. But in a market like this, things get shaken up. Be ready to act on the unexpected. That means being smart with your money and focusing on unit economics and sustainable growth.  
  • Play the cards you're dealt. Run your company keeping in mind your responsibility to shareholders, employees, and customers. You might get a lower valuation than you want or need, or a brand name investor might not do a follow-on. Whatever comes, know that you can get through it. Great businesses have been built and have scaled in all kinds of cycles.  
  • Focus on survival. Think about public companies. Their stock prices go up and down every second of every trading day, influenced by many outside factors. But they don't implode. You won't either if you build for the long term. Great companies emerge over years and decades. Not quarters.  

If you're in the Miami area (or want to travel) on April 20th and 21st, register for eMerge Americas! Let us know if you do. We'll have a whole team there and would love to meet you.  

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