A 'flat round' is the new 'up round': QED's advice to founders

The date that a company funded its last round is somewhat an accident of nature. That decision, however arbitrary it may have seemed at the time, today has profound implications for a business’ future.

If you raised in 2021 Q4, you’re probably sitting pretty. By contrast, if you have less than one year of runway left and you need to raise later this year, you might be in for a nail-biting summer.

In the coda to our most recent portfolio company CEO Summit in October last year, I told our founders that it doesn’t get any better than now. VCs were throwing money around with little to no diligence; debt markets were terrific; there was no inflation. The biggest problem companies had was hiring the best talent to allow them to continue to grow. These are the ‘salad days.’

The world has changed much since then, but the advice provided six months ago holds true today.

Focus on your unit economics. Focus on your company culture and what you stand for. Focus on having the right people in the right place. And most importantly, focus on your customer. If you do those things and do those things well, you can probably weather whatever is thrown at you.

So how long will the current chill last and how much runway should companies have?

There’s debate within QED to the former and a greater sense of alignment on the latter.

Some of my colleagues think fundraising windows will begin to slowly open as early as this summer. Others are using history as more of a guide – they know we haven’t hit the trough yet and they believe the resulting chill could last well into 2023.

Having started QED around the time of the last recession in 2007-08, we do have some of those historical data points to help us navigate this current climate. Using the past as a guide, it could take 18-24 months for us to reach the trough, which was around 50-60 percent its original levels. Keep in mind the S&P has only dropped 8 percent in 2022. During the last recession, it took 5-6 years to get back to the pre-recession S&P levels.

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In the past, we would typically advise companies to fundraise when they had three or four months of capital left, representing plenty of time to round up a solid raise while describing a business that was worth two or three times the valuation of the previous round.

Today, that same company needs to craft that same narrative with depressed multiples and are having to start that process six to eight months before they’re out of cash. Running haphazard processes for fundraising won’t work.

My co-founder and colleague Frank Rotman said recently that we've had such an incredible run for so many years that the venture community, the startup community, the public markets, have actually lost the narrative of what building businesses is about.

Money has been flowing into the ecosystem so regularly that founders have had the luxury of being able to focus on things five years out, seven years out, and talk about how great a business they could build.

It just happens that we've been in a long period where liquidity is very easy to come by, which means the building blocks for your business are cheap.

But consider this question: What is the intrinsic value of what you've built? How good are you at producing cash flows that are profitable? Don’t look seven years out; look to 12 months from now. Can you actually sell something for more than it costs you to produce? Are your unit economics above water?

That should be a question that all businesses ask all the time, but it's amazing that when capital is abundant, that question too often gets ignored.

If you can describe a cash-making machine that's growing nicely with healthy economics, you'll be able to fund it in any market environment. But if you’ve raised money and are still no farther along to proving that you can actually make money, then you're in trouble.

For those earlier-stage companies that were fortunate enough to raise a round late last year, start working backward from your next fundraise. VCs are drawing in their horns and asking questions.

If you're pre-seed, think about the order that you want to turn over cards. You're not going to be able to prove them all out with one big check being written in one round. There's no big bang, no single answer because you can't solve everything at once, so focus on your learning agenda and execute against it. Work backward from when you’ll next need to raise and the proof points you’ll need at that time. What you care about is running out of money. That’s force majeure! Once you've run out of money, you're over a barrel and that can change the power balance of your conversations with investors.

Also pay attention to the early election returns of product-market fit and what it costs to sign people up. If it costs more for every incremental customer that you originate, I’d be worried about that. Consider how big the TAM might be, and prove out your unit economics. You don’t have to be profitable, but you also can’t say that you’ll just originate lots of customers who will love you. The route to durable monetization is never more sine qua non.

So, set some specific goals and work backward in a very focused way. Candidly, it might mean doing less on your terms, but ask your investors what they will want to see when it is time for that next round. Being dilution-sensitive in these times is akin to being penny wise, but pound foolish.

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A critical concept that all businesses should internalize is that great companies are built on top of good companies and that the day you prove that you can earn money is the day that you've earned the right not to earn money.

The takeaway here is don't try to do everything at once. Build a good company first and then go get the money and the people to go build a great company. When capital is abundant, it's just too easy to say, "let me do three, four, five things at once," instead of sequentially building the company piece by piece.

CEOs are capital allocators. When capital is abundant, putting more money into growth is almost always the right answer. But when capital isn't abundant, figuring out how to turn over cards to prove the model actually works, might be more important than growth, especially at times when you won’t get rewarded for that growth. Be systematic and intentional.

Instead of growing by 2.5X, maybe the answer is to grow by 2X or 1.5X. Make sure that with the money you're saving, you're putting it towards an agenda, proving out the business and lengthening your runway and degrees of freedom.

The flip side to all of this, of course, is that there are potential opportunities ahead of you.

If you raised at the end of 2021 and your burn rate is low, there might be an opportunity to leapfrog competitors that are in survival mode preserving runway.

That doesn’t automatically mean to increase your OpEx and SG&A and build out functionality that you don’t need, per se, but if you have opportunities to put a dollar to work that general rates more than a dollar of return, that is always something to consider. It’s even more impactful if competition is weak.

One cautionary reminder, however: You don’t have to try to take down every opportunity simply because it is there. Make objective trade-offs.

The same holds true with acquisition opportunities. It you’re sitting on a war chest and another company is struggling to raise, it may seem attractive.

I think you should have a shortlist of companies that you would like to acquire and you should be talking to them. Start acquiring lots of data points and having those conversations. Keep in mind, though, that Frank will tell you that if you're buying something that couldn't fund itself, you're actually picking up a liability. Run the video and get a holistic view of a company instead of simply looking at a photograph of one snapshot in time.

Sometimes the answer is just to sit back and continue the status quo. Doing nothing is always an option.

I’ll wrap this up by saying that we are still much more optimistic than we are concerned for the long-term future of fintech and, by association, our portfolio companies.

The meta wind of the digitalization of analog financial services remains at our back and we are just 15 minutes into the first half (forgive the footy/soccer reference). In the long term, we are in good shape. Don’t let the short-term turbulence puncture your dream or take away from the enormous winds that are pushing us forward.

Remember that it is the financing environment that has changed, not the TAM or the market opportunity. A flat round is the new up round, and the QEDs of this world will be there to help you trade today’s noise for long-term tailwinds.