Why it's (still) a great time to launch a startup

Why it's (still) a great time to launch a startup

It's understandable for aspiring entrepreneurs to question whether or not this is a good time to start a company. After all, the stock market is down, inflation continues to rise, and hardly a day goes by without news of layoffs from a “unicorn” company or an ominous "black swan" memo penned by a top VC.?

It can certainly feel like the sky is falling around everything startup-related, but this is simply not the case - especially for new entrepreneurs at the earliest stages.

Let me explain why.?

A quick refresher

First, let me provide a (probably oversimplified) explanation for what is happening in later-stage VC right now. Feel free to skip this part if you already know.?

  • Venture capital has been an absolute goldmine of investment returns the last few years, eclipsing all other private asset classes. This led to a record-breaking amount of new money invested into VC firms in both 2020 and 2021, and an influx of non-traditional investors entering the space with very deep pockets (PE firms, sovereign wealth funds, etc).
  • This influx of money and competition for top deals, combined with a strong market for IPOs (including SPACs), led to a massive increase in startup valuations.?
  • This is why there were so many new "unicorns" the last two years. Remember - all it takes is a few investors to say a company is worth $1BN and voila, new unicorn!
  • Now, due in part to the turmoil in public markets, increasing interest rates, and fears of a recession, many VC firms are seeing a squeeze on their sources of future capital (from LPs, funds of funds, PE, etc).?
  • As a result, the sky-high valuations of the last few years are coming under greater scrutiny, valuations are dropping back to reasonable levels, and the exuberance we have seen in later-stage funding is fading away.
  • When later-stage funding drops, the same startups that recently raised money at massive valuations need to start cutting costs and targeting profitability, because they can’t rely on easy funding rounds to keep covering their inflated payroll. Investors are drafting memos warning their portfolio companies to prepare for this reality.
  • The collateral damage? Lots of super-talented people are being laid off due to no fault of their own. You can expect these mass layoffs to continue for the foreseeable future.?
  • There is still plenty of funding available at the later stages, but at lower amounts, lower valuations, and less founder-friendly terms.

Late Stage does not equal Early Stage

The above trends, and most of the venture news you are reading, are specific to the later-stages of VC. This should come as no surprise, since later-stage funding includes bigger checks, bigger names, and bigger stakes.?It makes the best headlines.

But if you are just launching a startup or are still at the pre-seed or seed stages, then you will be largely shielded from these trends for a couple of reasons:??

1. Your time horizon for raising later-stage funding is far out

If you are at the idea or pre-seed stage, you will likely not be ready to raise a Series A or B round for at least 12-18 months in a best-case scenario. By the time that happens, we will likely be in a completely different economic and investing landscape and everything I'm writing about now is irrelevant.

If you are at the seed-stage and might be looking to raise a Series A in the near future, there should still be no shortage of options to raise at a realistic valuation (though it will likely take much longer). If all else fails, there should be healthy market for extension and bridge rounds to keep you going (I explain why further below).

Not sure what stage you are at??See the chart below for some rough guidelines.

Chart showing typical company metrics needed for startup funding at the pre-seed, seed, and Series-A stages.


2. Funding looks much better at the earliest stages

While the trends of the last few years were a perfect concoction for sky-high valuations and late-stage funding exuberance, they were also a perfect recipe for a rebirth of pre-seed and seed investing.

First, those sky high valuations priced many traditional VCs out of deals. In an effort to remain competitive and find deals with valuations in their price range, an unprecedented number of these VCs started “moving downmarket” and investing in startups at earlier stages. This trend became so prevalent that you even saw many of the world’s largest firms raise new funds specifically for seed startups in 2021 - including Greylock ($500M), Andreessen Horowitz ($400M), Index Ventures ($200M), Sequoia ($195M) and more.?

Second, as a result of all the healthy returns and new money flowing into VC, 2021 was perhaps the best year ever to launch a new venture fund. Our sister company, VC Lab , launched 69 new funds in 2021 alone, and according to Pitchbook over 244 new VC funds were launched last year - an all time record.

No alt text provided for this image

The launch of new funds is particularly relevant for pre-seed and seed-startups, since most funds start small and as such, typically invest at the early-stages. Not surprisingly, the NCVA reported that a record number of microfunds (funds under $50 million) were raised in 2021.?

Finally, despite the rumblings of a slowdown that began late 2021, there was was still a record amount of money flowing into VC until at least the first quarter of 2022. According to PitchBook , U.S VC firms collected more than $70BN in commitments in Q1, an amount already more than half of what was raised during ALL of 2021 (the highest year on record). This was also more money than what was raised in 2008, 2009 and 2010 combined, during our last major global economic downturn.


3. Two words: “Dry Powder”

The most important thing about the record amounts of money that has flowed into the pre-seed and seed space??

A good portion of this money is yet to be invested.

This is called “dry powder” in the investing world, and PitchBook analysts estimate that just the existing capital in the system alone should cover 2.5 to 3.5 years of investments.

Combine all of this ready-to-invest capital with lower startup valuations, and you have a highly competitive early-stage environment that is ripe for a flurry of activity.


"I don't think the industry could ask for better conditions than all the capital that's available right now." - Kyle Stanford, Analyst at Pitchbook


This activity has actually already started: Crunchbase just reported an 11% increase in seed funding per month in 2022 vs 2021.

Yes, you will likely see a drop in total startup funding numbers over the next several quarters, but those numbers will be heavily skewed by the later-stages and the disappearance of the 'mega-rounds' of yesteryear. After all, it can take dozens of seed rounds to reach the amount of money in just one Series B. Just keep in mind that at the earliest stages things still look very, very positive.


Times of economic uncertainty are always a great time to start up

Finally, times like these are always a great time to start a company. I say this from experience: the Founder Institute launched in April of 2009, which was basically the nadir of the "Great Recession".

That period of time also gave birth to most of the tech categories that defined the last decade, like the sharing/ gig economy (Airbnb, Uber, Lyft, Postmates), direct to consumer wave (Warby Parker, Dollar Shave Club), online education boom (Udemy, Udacity), and personal finance (Wealthfront, Learnvest, SoFi) - just to name a few.

If you go back to the 2000 '"dot-bomb" crash, you will see a similar trend.

Entrepreneurs just seem to thrive in disruption.?

Why?

A lot has been written on this topic from people much smarter than me, but from my experience, during times of economic uncertainty:

  • Consumer and business needs change quickly, creating new problems that nimble startups are best positioned to iterate and solve.
  • Large companies spend a lot of time restructuring and shifting their strategy, slowing their (already-slow) ability to react to these changing customer needs.
  • Lots of amazingly talented people get laid off, and many of these people opt to join (or start) a startup until the job market improves. Startups get access to talent they typically would have no chance of hiring previously.
  • In general, the cost of doing business drops precipitously.

When the world changes, entrepreneurs are best equipped to adapt quickly and respond.


Just keep it simple

No matter what, the way to maximize your chances of building a great startup never seems to change.

  1. Focus on solving a problem that someone is willing to pay to solve.
  2. Build a sustainable revenue stream.
  3. Practice basic financial prudence.

Companies that do this will almost always be able to grow and raise funding, and will be particularly attractive in today's market.

But that is what you were already doing, right? :)

Thank you for sharing??

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Thank you for sharing??

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Jay Padia

Empowering Fundraising: US-Based IT Firm Specializing in White Label Crowdfunding Software Solutions

10 个月

"As a White Label Crowdfunding Software Provider, we empower startups to thrive in this opportune funding landscape. ?? #CrowdfundingSuccess #StartupGrowth"

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Kai Cahlil

CEO & Founder: Delta Infinite Space Tech

1 年

Glad to read an optimistic outlook in these times

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