3 Reasons Early Stage Founders Should Ignore The Doom Mongers
It seems there is a competition playing out online to hand out the most pessimistic advice possible to founders. A quick scroll on LinkedIn or Twitter would have even the most optimistic CEO shutting down their company and running for the hills. Such blatant doom-mongering might be good for views and likes, but it is nonsense.
For a start, the venture capital market cannot be treated as one homogenous mass. Advice given to founders raising a Series C round should be entirely different from founders raising a seed or Series A round. Yet the commentary online rarely makes that critical distinction, falling back on overly negative, unhelpful generalizations.
It is also not the first time we are facing a recession. Many founders and investors will not have lived through the dot-com bubble or the Global Financial Crisis. For those that have, the current circumstances feel familiar and are not unprecedented. Like all gloomy economic times, there are challenges and risks, as well as opportunities.
For founders at the early stage of building a venture-backed startup – that is, before and including raising Series A – there are reasons to be cautiously optimistic.
Seed rounds are happening
Most commentary around the overall health of the venture capital funding market looks at a short time frame. Headlines announce that venture capital funding is down in 2022 versus 2021. Digging deeper there are good reasons not to be overly alarmed.
First, early-stage funding is the least impacted and still amounted to $34 billion globally in the third quarter of 2022. The decline versus 2021 of 25% quarter on quarter and 39% year on year is a somewhat meaningless comparison. Venture funding could not continue growing exponentially and this correction was a matter of time. Moreover, and to make an obvious point, billions of dollars are still going to early-stage companies around the world – capital supply will naturally ebb and flow.
Second, looking at UK venture capital funding since 2013, the long-term trend has been upward, with 2021 an anomaly. Comparing 2022 to all of the years before 2021, funding numbers are still relatively healthy. And this makes sense. As a (pre-)seed stage investor, exits are so many years away that the prevailing macroeconomic conditions have relatively little impact on decision-making.
The danger for founders is setting expectations believing that 2021 was a normal year and that what was required to raise then is the same now. It has become harder to raise as a result of reduced capital (versus 2021) and re-calibrated risk appetites, but founders are still closing seed rounds. The market has changed but remains open.
Series A funds are active
For Series A funds, 2021 was a challenging time. Valuations were sky-high and fundraising processes moved with incredible speed, making due diligence and robust decision-making challenging, For many funds without a premium brand, it was a struggle to get access to the best companies. In 2022, things have returned to normal.
Looking again at the comparison with 2021, Series A funding in 2022 is the least impacted – down just 23% year on year. This reflects the fact that many strong companies were raising and continued appetite for funds to invest in them.
The re-calibration at Series A impacts founders in a few ways.
Most notably, valuations have come off their 2021 highs. Huge rounds at high valuations lionized in 2021 now look over exuberant at best or rash at worst. They are also creating headaches for founders who are struggling to grow into them and raise their next round on palatable terms. Today, giving away more of your company for less money compared to last year can feel like a negative thing, but, within reason, raising the right amount of money you need for a sensible dilution worked before the boom and will continue to work in the future.
The type of funds in the Series A market also continues to evolve. Multi-stage funds are cautious, busy looking after their later-stage portfolio companies, with some dipping their toes into the water with seed cheques to stay active and relevant (and justify their management fees to LPs). Stage specialists are enjoying their moment in the sun – able to win opportunities that may have eluded them in 2021. Processes have elongated and take up more founder time than before as funds dig deep into every opportunity, keen to avoid any sub-optimal decision-making. It is painstaking for founders but results in more durable early relationships with investors.
Expectations at Series A have also been re-set to pre-2021 levels. The days of pre-emptive rounds when companies only have a few hundred thousand dollars of revenue are over. Metrics that founders need to achieve to have a realistic chance of securing a Series A funding round are fluid, but the now well-known SaaS Funding Napkin is a helpful guide.
Lower valuations, longer processes, and more rigor around required metrics do not appear like great news for founders, but they represent an overdue return to reality. They also do not mean that the market is closed. As with seed (and pre-seed), funding levels at Series A remain robust against historic norms and many founders are continuing to close rounds.
Time is on your side
Early-stage founders today will be looking for growth funding – Series B onwards – several years from now. Growth rounds are hard today and nobody knows when the current cycle will turn. However, in two or three years we will likely be back on the upswing, with capital and risk appetite returning as the public markets thaw. Nothing is guaranteed, but founders starting or early on their journey now are much better positioned than those who, unfortunately, got caught in the eye of the storm.
Founders reading advice to slash their headcount, dramatically cut marketing budgets, aim for ‘default alive’ or shut down their company, should think carefully about whether that advice is relevant and proportional. In these challenging times, many commentators are taking worst-case scenarios to generate clicks, or extrapolating their individual experiences to make assumptions about the entire venture capital market.
Being the founder of an early-stage company has always been hard. It is harder in 2022 than in 2021, but not materially harder than it has been over the past few decades. The right approach is cautious optimism, shutting out the noise, taking advice from a small number of people you trust, and not letting fear dictate your actions.