7 trends to note when raising money in the current climate

Over the past few months, I had the opportunity to share my thoughts with institutional investors, accelerators, startups on the trends we are seeing in the investment climate that many would call a ‘funding winter’. These are afterall, unprecedented times. The seismic shifts in the capital markets as we turned the corner of 2022 into 2023 has changed the perspective of many investors on how they see an investable asset. While there is still sizable interest in companies that are registering high growth in lieu of profitability, that interest is quickly waning. Companies that used to command high valuations despite losing lots of money had to settle for ‘down rounds’, with new money invested into them at drastically lower valuations. Those with cash would hold off raising money for the next 24 to 36 months, in the hope that the ‘funding winter’ will soon be over.

Some trends have emerged from the buy side of things (aka investors and acquirers) and some metrics and strategies of startups could make them look better than their peers.? So let’s delve in.

Trend #1: Investors have problems raising funds themselves

A study done in 2017 analysing more than 270,000 VC investments over 35 years in 20 VC markets worldwide revealed that for once interest rates reach 1%, every 1% increase in interest rate will result in close to 3.7% decrease in VC fundraising success. Since May 2022, the Federal Funds Rate has risen from 1% to 5%. So if this study is accurate, we should expect VCs and other investment funds having a tougher time raising funds from investors. And the anecdotes from the ground seem to corroborate that. “I think (a certain VC) is unable to close even 30% of its target,” quibbed one fund manager, who was also facing difficulties raising money for his multi-Family Office. He explained to me that most investors (LPs) are now more keen on lower-risk investments since the rising interest rates have made them more attractive than before. Some of them are also more liquid than investing in private enterprises, where capital is stuck for some time, not to mention that these investments also tend to be more risky.

All these means less money going around to be deployed to companies who need them to grow. While the investment philosophy of VCs and some Family Offices may remain unchanged, the preference for targets and the manner in which they deploy their capital seems to be evolving in the following ways.

Trend #2: Moonshots giving way to sustainable growth

Prior to 2022, VCs were tolerant of startups who could gain market share and growth at the expense of generating profits. Back then, investors could wait for startups to turn the corner as they burned their way to profitability. These have been the investment theses of Pharmaceutical and biotech companies for many years, where pharma and biotech startups would need to burn cash as they innovated products that could become silver bullets in the healthcare industries and dominate the market on monopolies through comprehensive patent protections. Back then, investors across tech industries were willing to adopt a similar kind of investment posture. This has changed. “Growth at all cost” gave way to “Clear Path towards Profitability”, and is increasingly evolving towards just “Profitable companies with good growth potential.” Many investors these days would rather see startups focus on generating quick wins and achieving positive cashflow from revenue generated earlier than to wait for the possibility of a big breakthrough that could make the startup own an entire market segment and impact the world’s population systemically.?

Trend #3: Depth is preferred to breadth

For some time, VCs were quick to deploy capital and quickly raise the next fund from their investors. Now, facing the hurdles of raising more money, some investors have shifted their approach to focus on depth rather than breadth. In the past, investing funds for early stage ventures might have adopted the ‘spray & pray’ approach, where a small amount of money would be invested in a large number of startups as they monitor and watch for those that show more promise to double-down and help them grow. These days, the approach may be slightly different: there is still a fair bit of dry powder to put into startups, but investors would rather put more in less targets. So investors would prefer to spend more time looking at the stack of pitch decks on their table, then engage with founders to understand their businesses in depth, before picking a handful that really show promise supported by strong fundamentals, and decide to put more into these companies to help push them to the next level, fast. So what used to be a target pool of, say 30 companies, may now be down to, say less than 10 startups, each getting more money. This leaves the other 20 companies scraping for what’s left on the table from other investors. In fact, Techcrunch in January, reported that some funds are sitting on a tremendous amount of dry powder but they are careful to look at companies that have demonstrated market demand for their products with reasonable asking valuations.

For the startup founder, all these means that unless your enterprise is premised on a solid growth story that is supported by financial metrics that suggest you’re on the right track towards realising this compelling vision that you’re proposing in your deck, you may not be able to get the help you need, in time for you to make that push. And one of those metrics that investors are now quite keen to look at is revenue.

Trend #4: Revenue is king

Right up to the recent past, early revenues used to be frowned upon by some investors because they view the drive towards getting such revenue may dilute the efforts of the founders to build something that could dominate and own the market. Back then, we may hear investors telling us to “focus on building the best product there is,” or “don’t be afraid to spend to make something splendid”. These are still relevant and worthy aspirations that founders and their investors have and such ideals aren’t bad by themselves. But these days, an enterprise that doesn’t demonstrate pragmatism in its go-to-market strategy by showing that some people would indeed pay for the precursor of its grand vision risks being viewed as overly idealistic and too early for many investors. Quick wins is the name of the game in these times. And founders need to find the fastest possible way to reach and put an offering before the customer, then get him to buy to show that this is something people actually want. The startup doesn’t need to be collecting lots of revenue yet, but it has to show that some money can be made to present a datapoint that investors can use to extrapolate the value potential of the enterprise. Even if money is not collected and deposited into the bank, an order book that shows a list of committed contracts or sales to different customers could be enough to justify the value of the offering, and the enterprise that produces it.

The ability to demonstrate modest product-to-market fit in the form of securing sales and generating revenue is an important consideration by investors who are looking at a deal. The grand vision can wait.

Trend #5: Age of a startup matters less; fundamentals matter more

I spoke to a fund manager recently, who told me that he would be keen to look at companies which are profitable, regardless of their age. “The company could be a startup or a 30 year old company. As long as it is booking profits, we would be keen to look at it”, he said. But he suggested that this is a temporary posture that he is adopting “now, at this time”, and that this could change with the evolution of market sentiments. It used to be that a company older than 5 years tended to be viewed as past its prime and could have problems raising money from investors who were keen to bet on the next big thing. This has changed somewhat. These days, companies that are actually making money (profits) rule. And because of that, those that succeed in raising money from investors often do so with moderate asking valuations than before, where non-financial metrics could be readily used to justify high valuations.

This is also good news for older companies, as it actually opens the opportunity for these companies to score a nice investment, as long as the asking valuation is duly justified and reasonable. These days, the fundamentals of a good business such as profitability, profit margins, revenue growth potential are back in favour. And this is a good thing.

Trend #6: Shorter runway exits emerging

A blog post by the Silicon Valley Bank (nevermind that it went under, it’s still a good insight to share) suggested that the challenges faced by founders at the pre-Series A stages could push them to concede with earlier-than-preferred exits through mergers and acquisitions. While this doesn’t necessarily result in favourable fund returns for the investor, it’s still something good for early investors and it may ironically bode well for the founder. By escaping the prospect of raising a downround or facing an impending closure of the enterprise, and exiting in the process, the founder actually looks good, since she can now boast a zero-to-exit experience. And achieving all this over a short period of time. The founder is then free to start the next rocket ship to solve another problem, and this time, she shouldn’t have much problem getting people to put money in her new startup - she is, after all, someone who has successfully ‘been there and done that’ in the startup space. She is, what I would call, a Fast Founder.

Trend #7: Strategic industries continue to attract investors and governments want a piece

Increasingly some strategic industries with systemic impact on societies and human wellbeing continue to attract investors. This is especially so for companies operating in the deep tech, ESG, cleantech, med tech and health tech spaces. In some regions such as Singapore, EU and China, the respective governments seem keen to help grow these sectors for strategic reasons. The wise founder should be attentive to these pockets of support and structure her business in a way that captures the best of all worlds, where possible. This isn’t easy as there are several elements to consider, including corporate structures and IP ownerships, to name just two of them. But if structured properly, the enterprise could reap the best of funding support and access to the right partners in different regions to rapidly grow and scale the business.

Be Pragmatic and Act Fast. The Raise Money at the Right Time

In my upcoming book, The Fast Founder: from startup to exit in 36 months, I discuss the numbers and metrics that founders could look at when growing their ventures and when could be the appropriate time to raise money. Founders could focus on bootstrapping and get the business up to a point where it becomes really attractive to investors before going out there to look for smart money, and there are innovative and pragmatic ways to bootstrap and still get a lot done.

When looking for money, we need to adopt the right posture, sell the right story, and choose the right time to do so.