Startup Fundraising During Challenging Economic Conditions: 7 Strategies and Tips

In today's highly competitive and volatile economic landscape, fundraising for startups can be particularly challenging. It is taking longer than ever to raise capital, and the founder’s runway is currently being threatened.

This journal entry explores the difficulties startups face during high-interest rate environments, scarcity of risk capital, and elevated cost of capital, as we are experiencing in 2023. Discover actionable strategies to overcome these obstacles and successfully raise funding in these tough times.

Understanding the Current Scenario

The current macroeconomic environment presents unique challenges for startups, including high short-term treasuries and difficulty for venture capitalists to raise capital. Entrepreneurs need to understand how these factors are potentially affecting them:

1. Increased Borrowing Costs: High-interest rates make borrowing more expensive for startups. When seeking traditional bank loans or debt financing, startups may face higher interest rates, resulting in higher interest payments and increased financial burden. This academic article explains further the impact of high-interest rates on startup financing.
2. Investor Risk Aversion: Investors become more cautious and risk-averse in high-interest rate environments. With the cost of borrowing increasing, investors are often more reluctant to take on additional risk by investing in early-stage startups. They may prefer safer investment options with lower risk and more predictable returns, like treasuries and fixed-income instruments, rather than riskier bets.
3. Decreased Investor Appetite for Equity: Inflationary scenarios, coupled with high-interest rates, can shift investor preferences toward fixed-income securities rather than equity investments. Investors seeking stable returns may opt for bonds or other fixed-income instruments rather than investing in startups, which are inherently riskier.
4. Impact on Valuations: The high cost of capital can influence startup valuations during fundraising. When the cost of capital is high, investors expect higher returns on their investments to compensate for the additional risk. This may lead to more conservative valuations and lower investment offers for startups. It is imperative for startups to understand how to calculate a startup valuation .
5. Longer Timeframes for Fundraising: Raising capital becomes more time-consuming in high-interest rate environments. Investors may conduct extensive due diligence, scrutinize financial projections, and evaluate market conditions more thoroughly before committing funds. The prolonged fundraising process can strain startups, potentially leading to cash flow constraints or missed growth opportunities. As the image on the top of the letter shows, plan accordingly to raise funding to extend your runway for at least 14-18 months.
6. Limited Availability of Risk Capital: As stated by Forbes , investors are struggling as well due to the scarcity of risk capital. Venture capitalists and other institutional investors may find it challenging to raise funds from limited partners due to increased risk perception. This limited availability of risk capital reduces the overall pool of investment capital for startups, making fundraising more competitive and demanding. If lenders don’t lend, borrowers can’t borrow.

Although we could write an entry alone on macroeconomic factors currently affecting startups in 2023, let’s instead move into actionable strategies and tips on how to raise investment capital from venture capital in today’s landscape.

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Strategies and Tips for Raising Capital in 2023:

1. Focus on Traction: Maximize customer adoption, revenue growth, and market validation to attract investors seeking companies with strong traction. Remember why you became an entrepreneur (hint: to make money). Don’t wait for a “perfect product”; instead, focus on getting an MVP done and quickly test product-market fit. Traction builds on market acceptance, and once momentum is ready, growth will follow. Here is a nice traction metrics list to grasp on the idea. Go sell!
2. Alternative Financial Instruments: Explore revenue-based financing and other non-equity funding options to diversify funding sources and access capital. The adoption of SAFEs and KISS has increased, and more investors are willing to use them. Likewise, issuing warrants and similar derivatives can power your financing round. Leverage these flexibilities and be creative.
3. Valuations and Realistic Expectations: Set reasonable valuations aligned with market conditions to attract investors. Flexibility and negotiation are key. It works better and easier when you understand where you stand and know your valuation range . 100X multiples on revenue are no longer working; just see the graph below. Startups are being devalued, and many are going bankrupt due to absurd valuations that are unsustainable in nature. Be realistic!
4. Focus on Profitability and Burn Rate: Emphasize a clear path to profitability and optimize costs while maintaining growth potential to instill investor confidence. It’s difficult to instill confidence when your SaaS company margins align with those of a supermarket . Growth now and profit later only works in expansionary macroeconomic environments. When things get tough, investors seek tip #1.
5. Build Strategic Partnerships: Collaborate with established companies to access resources, expertise, and potential funding. Strategic partnerships enhance credibility and market reach; many of these partners turn into investors. Corporate partnerships are a great way to test product-market fit for B2C companies looking to turn into B2B.
6. Leverage Government Support and Grants: Research and tap into government initiatives, grants , and funding programs designed to support startups during tough times. After the COVID pandemic, many government initiatives focused on economic impact and development have surged. Leverage these opportunities. Accelerators like parallel18 provide early-stage startups with equity-free funding, access to capital, and corporate partnership for international founders to accelerate their businesses.
7. Diversify Funding Sources: Explore angel investors , crowdfunding , corporate venture capital, and bootstrapping to diversify funding and reduce dependency. You’d be surprised that many of today’s success stories are startups that bootstrapped their whole operations!

The Dr’s Order #2

Remember, fundraising is an excellent way to leverage growth and expand, but it should not be a conditional variable of your entrepreneurial journey.

Successfully raising capital during challenging economic conditions requires strategic approaches and a lot of flexibility or bargaining power. Prioritize traction, explore alternative financial instruments, set realistic valuations, emphasize profitability, build strategic partnerships, leverage government support, and diversify funding sources.

Resilience, adaptability, and relentless pursuit of your vision are key attributes that can drive your startup's success, regardless of the economic climate.

In the following week’s entry , we will explore additional valuation methods to help startups and investors achieve realistic measurements.