Lower Valuations, Shut-Downs, Investment Pause. What’s A Founder To Do? Eight Investors Weigh In
This article was written in collaboration with Taylor McAuliffe, Researcher and Writer from Altitude Accelerator, a non-profit innovation hub and business incubator which provides programs to help founders grow and scale.
The investment frenzy we all witnessed in the fall of 2021 has suddenly come to a standstill. The bubble that has pervaded the VC ecosystem has finally burst and pundits are echoing blame on economic shocks like a pandemic that paused the supply chain and created high unemployment, and then followed by the invasion of Ukraine that further curtailed access to commodities, instigating rising food and fuel prices. The resulting inflation, the degrading consumer confidence and the higher cost of capital have made the once bullish investor pull back the reigns to re-evaluate their portfolio and spending strategy. The fallout of this free-for-all has seen start-ups downsize or close their doors, and brace for lower valuations in the hope of securing funding.
Many startup founders have asked us, as investors and accelerators, the path to weathering this economic downturn. We curated a list of US and Canadian seasoned investors to convey their perspectives on the state of the market and what this means for valuations, resource allocation and raising money during this precarious period.
We started with a simple question: Why should founders be paying attention to this down economy?
Investors agree: Behaviours must change. Founders need to conserve capital and runway.
Founders have a responsibility to notice the signals of the changing economic environments. The prevailing economic downturn is signaling, in many cases, that founders cannot rely on business as usual, the way it has been over the last 12-24 months. Money is tighter, and investors are going to be more selective. However, if founders keep their eyes open, there is a momentous opportunity to flex business strategies and make prudent decisions about how to utilize and prioritize resources and come out on the other side. We asked investors why it is critical to pay attention at this critical time and what it really means for them.
Jessica Peltz-Zatulove, founding partner of Hannah Grey VC and Cofounder of Women in VC, argues that paying attention to the downturn and its impacts on funding is critical to remaining afloat:
“The goal for founders needs to be giving yourself as much optionality today for the long run, so you’re not staring down a barrel with three to six months of cash left and are like, ’I need to raise again’ because you have to be proactive about it today.”
Peltz-Zatulove urges founders to take the first step towards weathering this storm by recognizing that business strategies and behaviors we have seen over the last 12-24 months will not continue to work the way they have been. Recognizing this need for change in their plan and tactics will be necessary for start-up survival:
“They’re going to need to conserve capital, and they are going to need to conserve runway. And that is going to come from having to change behavior and a way of operating their business they were not used to doing over the last 12 to 24 months.”
Similarly, Founder and Managing Partner at Preference Capital, Andrew Opala, warns founders that the changing environment means sources of funding will become scarce, and those looking to fundraise will need to prepare to be met with unwelcome news:
“The problem becomes they do not have access to liquidity. And they [investors] become very picky when they give money to companies. So, there is a good chance if you show up and ask for money…you are not going to get your money. And it is not going to be you are going to get a little bit of money, you will not get your money. Period.”
While only so much about the length of this downturn and its impending impacts can be foreshadowed, navigating these times will be critical for start-ups to survive. Once founders have accepted the environment is changing, they can then look at how to realistically value themselves, allocate resources, and stand out to investors during this time. Gayatri Sarkar, founder of Advaita Capital, a firm which invests in growth-stage technology startups and is focused on celebrating diversity and championing the voices of women and diverse GPs and LPs, provides advice on the future of this downturn and the mindset that founders should be adopting:
“There are multiple agitators influencing today’s situation: The global pandemic and the Russian/Ukraine War. Many bad actors have taken advantage of the easy and low-interest money. While the Fed is now controlling inflation many large hedge funds and public market investors that had flocked to the growth stage have either moved onto the early stage or completely left the venture capital asset classes. As recession is knocking on the door, many LPs and investors will take a conservative approach to high-risk high return asset allocation. I believe this will directly affect emerging managers as well as startups that are in the market to raise in the next few months. Though, personally, I do not believe we are in the 2000 era burst as tech startups’ value creation have brought scalable solutions. Timing the market is a fool’s errand yet here we are trying to access the risk. My suggestion to startups would be to build an anti-fragile process within their business capabilities from the beginning, to prepare for a sector-based downturn or a major global recession. Cash is king and now the focus will be to bring strong revenue than accelerating the growth pedal with a high burnout rate. Building a product with high leverage with no path for monetization and a higher churn rate is clearly betting on certainty. The key element for anti-fragile growth product architecture is an agile product with a strong interoperability and promise market fit for your decentralized community.”
SLOWDOWNS MEAN RE-EVALUATING VALUATIONS
This current market has spurred the investment community into correcting prices that have suspended reality, in many cases. Inflated valuations, a seemingly endless well of funds and VC spending frenzy – all were predestined to end.
Sarkar explains what led to this downturn:
“We saw COVID put a stress test on our supply chain in every way like food and medical supplies. It also puts a stress test on socioeconomic power, and the stress test on human emotion from isolation to unemployment. A slight recession emerged as a sharp drop and a sharp rise because of the government stimulus. This stimulus effect brought free money that came into the system that helped fuel spending. And it came into all different layers of the system… that enabled more investment in tech, influencing people to raise more and increase the valuation of their companies.”
What Sarkar has described is the resulting free flow of money that saw companies raising every six months and much higher valuations at more unwarranted rates. What this means?
“There was a time when unicorns were called unicorns because they were barely found. Now they are everywhere. So, everybody is running a unicorn! So now where is accountability?”
Down rounds are expected so build a good company, mitigate risks, be mindful of the value you are creating, and you will be the cream that rises to the top.
Peltz-Zatulove, also Cofounder of Women in VC, challenges founders to think two chess moves ahead:
“Venture Capital and business planning is not only thinking about what valuation can I grow today, but also what valuation can I 2X or 4X in that 12-to-24-month period. So today, founders should be thinking about what an appropriate valuation for me is based on my domain expertise, based on my customer pipeline, based on the market opportunity, based on the business traction to date that I am going to be able to grow into. Coupled with what is the valuation that I am comfortable with that will give me the value and the dilution that I am comfortable with.”
Neeraj Jain, General Partner of MATR Ventures, a seed stage fund which invests in underestimated founders: women, Black, Indigenous, People of Color (BIPoC), LGBTQ2S, and Neuro-diverse communities, concurs that there will be less appetite for risk. The bloated valuations of the previous year will naturally mean there will be less competition from VCs trying to get into deals. His advice is the same whether it’s an up or down market,
“Build a good company. Focus on the obvious things: revenue, costs, the team… what kind of IP do you have? Are you disrupting the market? I think one of the things that’s going to change is that money will be a little bit harder to get so now you are going to have to show more traction than before… it is really about the package: What actual value are you creating? And that needs to be real.”
Julianne Zimmerman, Managing Director, Reinventure Captial, which invests in US-based companies led and controlled by BIPoC and/or female founders of all identities, says that founders should think less about valuations and focus on the direction the company is on, how they are accessing capital and the most appropriate terms that track to their objectives:
“What I always encourage founders to do is to think ahead about all the capital you will expect to raise: equity, debt, whatever capital you will expect to raise to reach your objectives. And then think about how you want to position the company at each of those junctures such that the capital you’re taking in really puts you on the best possible trajectory, not only for the next milestone, but on path to that ultimate objective.”
Danielle Graham, Managing Partner of Phoenix Fire and Cofounder of The Firehood, an angel fund and network focused on women in technology, emphasizes the need for founders who they need to target for capital.
“One positive side – the type of people who may be looking to reinvest their capital in alternative assets will be more incentivized to participate if they have access to high potential technology startups. When people become risk averse, they use an economic downturn as an excuse to not participate and take that risk for the potential upside, whereas an intelligent investor, in comparison, would participate.”
For the founder, Graham notes they need to be open to new considerations at this time when dilution will be of greater concern if the founders raise less capital.
“That will obviously lead to more post funding strategies that will mean being frugal with your capital, managing cash flow, curtail hiring and giving employees confidence during this downturn. Watch spending and give yourself as much runway as possible because you are going to have to survive through this funding scarcity.”
Shirley Speakman, Senior Partner, Cycle Capital, an impact investment company focusing on cleantech, describes the VC appetite to put capital to work in new entities is going to wane because they will need to focus on the health of their existing portfolios. For founders, the key to survival is risk mitigation and cash management:
“Do as much as you can to mitigate the associated risk, so make sure that you have revenue coming in, that you have longer term contracts, that you can do whatever you can with the business that you must give the potential investor more confidence that the risk is controlled. And manage your cashflow like there is no tomorrow – have strong control over your cash forecast. Understand when revenue is late, and its impact on payables and overall cash flow. Know what levers to pull you through this time. People hear that and they often say, ‘Okay well then, I must cut [staff].’ You cannot cut bone because you lose a limb when you are trying to recover, so it’s important to be judicious and prudent with your cash.”
Opala of Preference VC indicated that while down rounds may be inevitable at this time, the key is ensuring your round is always better than the last one; your valuation is higher, and you’re good!
“Airbnb had a down round when there was a market downturn, and they crushed the ownership. Now they’re doing well! Founders don’t want to risk everything that will make the company go under because they valued it too high, thinking they were going to roll through this. There is no problem with including ratchets in your valuation that allow founders to get back investor shares if they reach specific valuation milestones.”
All agree that cash is king. Jain, of MATR Ventures, emphasizes focus on increasing revenue: “Can you launch something a little earlier than you originally intended to? Can you put a premium version out there to increase your price?” Sarkar adds that if you benefit from having a large injection of capital you need to focus on making excellent operational choices while reducing the burn rate and having the net dollar retention.
Alaric Aloor, General Partner at MATR Ventures, also recognizes the “exceptionally bloated” valuations in the last few years. This downturn, to him is a contraction where money is no longer easy to attain. This period is a reckoning, and he believes the “cream will rise to the top.”
“For a founder raising in this contracting economy, it is important when you approach potential funders to show them the sum of all your resources … talk about your intellectual capital, your technology, your brand value and financial assets you bringing to the table. And because there is no universal universally accepted formula to determine the valuation, we must start with the amount that you may want to exit with, factoring in the expected return on investment, the amount the founder invests, and the stock holding percentages that we want to negotiate with the founders to arrive at this this pre money valuation.”
TIME FOR TIGHTENING BELTS AND BEING STRATEGIC ABOUT HOW RESOURCES ARE ALLOCATED
Slowdowns do not necessarily mean the investor will change their investment strategy. In fact, this may be a good time to Invest. Founders should remain customer obsessed.
Zimmerman, of Reinventure Capital, maintains this current environment has not changed the way they are investing:
“Reinventure came into this downturn with an investment strategy that was already essentially orthogonal to most of our venture capital peers. We invest exclusively in US-based companies that are led and controlled by BIPoC and/or female founders at breakeven and poised to grow profitably. So, we are already taking a very different stance in our identification of opportunity in the way we think about value and risk and the way that we identify promising founder teams and their companies. And we are not changing our strategy, our criteria, our approach, or our methodology in response to the shift in the economy. What we are doing is looking with the founders at their respective market conditions and talking with them about how they are thinking about their customers, their suppliers, and their strategic partners, and how they are thinking about the health and viability of those networks, because no company stands by itself.”
Jain, of MATR Ventures, does not see this time as changing the investment criteria.
“This downturn was expected, and the economy will recover again. We should not panic as it is a normal course of our economic system. It also does not mean that VCs will not invest – instead, they may just look at deals with more scrutiny. But I will still look at the same criteria: whether it is traction, a good business plan and business model, the team – all those things are important to me. And the bar might be just a little bit higher to get funded… However, as an investor I do feel there may be more opportunities to see deals that may have been gobbled up before I had a chance to see them.”
Opala, like Zimmerman, illustrates the importance of the customer, which is part of Preference Capital’s investment thesis:
“The only thing that would change with us [at Preference Capital] is being critical when it comes to the founder’s customer. So, when an investee says, ‘I have this great customer,’ we used to ask for their name, looked on LinkedIn and that was good enough for us. Now we are investigating more. One of our GPs is flying to Kentucky to interview the customer of one of our investees. That is how worried we are because we will pay for a $2000 plane ride to save us $500k and a bad decision. So, we are being extremely critical of the customer story because there must be a clearly defined segment we can measure and put a number on. I can go into LinkedIn to find out how many of these “chief innovation roles,” for example, there are to get to market size and scrutinize the company on the revenue they are going to bring in every year from this market. So, in choosing companies, we make sure we interview the customer(s) they promised to bring to the table is real.”
Peltz-Zatulove, who is a pre-seed investor, considers this time the best time to invest. Like Opala, being aligned with the market is critical.
“This is when creativity is at an all-time high. This is when you start to see a lot of the challenges, but resilience really materializes for a lot of founders that are ready to start new business, so we are not slowing down our pacing. We plan to continue to invest and execute our strategy as normal. We are looking forward to the valuations coming back down to reality at the pre-seed stage. We are more price sensitive and the last 12 to 24 months of deciding to invest or not was the state of the market. Funds deployed too quickly and are sitting with portfolios that are heavily overvalued right now. For us, it is just being more disciplined on valuation and putting an even bigger emphasis on team. The founding team needs to be nimble, open-minded and be a student of the market with a healthy obsession with the customer.”
We have witnessed a tech market seeped in panic, layoffs, and shutdowns. Founders should lead through a crisis with empathy, responsibility and shed the “fire fast, hire fat” startup mentality.
Sarkar, of Advaita Capital, realizes that walking in the shoes of founders who must make critical decisions that impact the team, and the growth of the company, is not an enviable position:
“Founders, especially at a time of high uncertainty, need to be responsible, and empathetic – understanding that their employees may be breadwinners of their families. Then again, in a startup world where you fire fast and hire fat, the expectation for stability is less likely. Being a founder that needs to make these types of decisions during a recession-driven economy or where we are very much tied to our bottom line is tough. It will be interesting to watch, but I have hope that a lot of founders will bend towards reducing salaries of senior management and among staff to stave off layoffs, while driving meaningful impact and product led growth.”
For Aloor, GP MATR Ventures, and CEO of Archon Security, a 9-year-old company with 19 employees, human capital is the most important to a business, even during a downturn. He alludes to this “fire fast, hire fat” mentality Sarkar introduced:
“When I talk to startups that I advise and they are looking to hire, I tell them to look for cultural fit. More importantly, are you going to be able to provide this person you are hiring with sustainable employment opportunities for growth over the long term. I am not talking to one year or two… but 5-10 years because as a founder and CEO, if that is your vision, you are going to be bringing on the right pieces to fit NOT because you received some funding. I advise against this because it is a bad model for growth without actually selling… So, when I advise startup founders about hiring, it is to avoid layoffs that we are now seeing across industry i.e., explosive hiring that companies have done with no consequence of looking at the long term. When you are a company that wants to be stable and in the long game you must have sustainable hiring processes and practices. Without that, the faster you go up, the faster you come down.”
Graham, Phoenix Fire, illustrates for founders the importance of aligning core activities to core milestones, but more importantly, effectively negotiating their worth if they are hitting those milestones:
“Be frugal. Be focused no matter how incredible your product is. Manage your activities to hit those milestones, leveraging early-stage opportunities that investors are expecting to warrant the next round. Companies doing well will continue to get funded. There is still capital in the market. It is getting those companies forward with 2x to 4x return before earlier investors or common shareholders get anything, so they do not want to be at the bottom of that waterfall when you have heavy liquidation preferences. You need to be negotiating that lever and fight harder on your deal terms and rights. If you are doing well, you have product market fit and you are hitting your milestones then you should have less to worry about because you are building a viable company.”
Similarly, Peltz-Zatulove of Hannah Gray VC defines the need for empathy with a dose of reality.
“So, for founders, I would look at founding team with a blank slate and redefine those KPIs and those milestones for the next … 18 months. Make sure you have a clear idea about what you need to accomplish to get to those milestones. With a fresh set of eyes think about who on your team you need to accomplish those goals and those KPIs for the next 18 months.”
Speakman, of Cycle Capital, expresses the importance of transparency when a founder communicates with employees.
“If you try to hide things from the employees or gloss over it, people will see through it. And inevitably, if you must raise capital and you need to reduce your valuation, this will scare employees, and will trigger perceptions of the company being worth less or heading into a downward spiral. So, again, managing the cash without cutting bone is an important part of giving employees confidence that you can manage through this time that’s ahead of us.”
Zimmerman, Reinventure Capital, agrees with this prevailing view of rigorous cash management:
“For founders who can either alter the product or service offerings so that you can generate revenues in excess of costs if you haven’t been, or bring your revenues, at least in line with your costs if you haven’t been, I strongly encourage you to do so. So, if you’ve been burning hard, hard, hard, and you are concerned about conserving your ability to make decisions, focus on bringing your revenues in line with your expenses. That may mean reducing your burn rate. But it may mean offering new products or services or offering new tiers or offering new means or even reaching new customers to engage with your product or service — strengthening your customer base bodes better for resilience and future opportunities for growth than simply cutting back. For founders who are already operating at or above breakeven, I would say really work to understand exactly what the drivers of your profitability are and double down on those.”
Jain, MATR Ventures, emphasizes the importance of team:
“They should involve the team and planning. How are we going to conserve cash? Involving the team in that is important. You do not want to create fear. You certainly do not want your good people to leave. They need to feel confident that you have the right plan.”
MOVING PAST PANIC & UNCERTAINTY: INVESTORS ENCOURAGE WAYS TO STAND OUT
Many founders are asking, ‘How worried should I really be?’ Downturns do not mean we need to panic. Pay attention to the market while you remain prudent with your spending.
The downturn has undoubtedly brought feelings of panic and uncertainty; however, investors say there are ways to persevere. Speakman acknowledges that founders should be aware of the increased difficulty this downturn will pose on their ability to create and sustain a successful business but follows up by saying this difficulty does not make success impossible. Instead, if founders can capitalize on the downturn and standout to investors, they will be part of the cream that rises to the top:
“Scarcity breeds focus.If you can remain focused on the customer, your cash management, and the projects that need to get done, that will help you stand out.”
Sarkar, Advaita Capital, believes that founders should be worried because of the unknown that comes with changing economic landscapes. We have not yet seen how far this downturn will go, and “battling against the unknown can be extremely difficult for founders.” Her advice is to take this worry and use it to make choices that lead to a more optimized, efficient, and well-connected business.
Peltz-Zatulove is optimistic, advising that during this time if you, as a founder, are demonstrating key character traits and taking on full leadership for your company, there is no need to panic as the good founders always get funded:
“Being really scrappy, and nimble and resilient, [are] the best traits to have right now.”
“Founders that demonstrate what they are building, how they are executing to product milestones, successfully shipping product, building a team, and inspiring people around you – there’s always going to be capital for that.”
Jain, MATR Ventures, and Zimmerman, Reinventure Capital, also advise founders not to panic:
“In general, people should not really be panicking. In the same way, you know, I think when times are good, it’s not always a time to just open the floodgates and spend all your money. So, if you’ve been a prudent operator of your business, there really is no need to panic at all,” says Jain.
Zimmerman adds that while attention towards the changing economic landscape is a responsibility that must be honed by the founder/CEO, it is equally important not to lose sight of other operating contexts of their company. Hyper focusing on managing the downturn will not accomplish anything:
“The economy or the markets form one part of the operating context of your company — a significant part, but one part. I think that a Founder CEO who does not take the markets and the economy into account at all is failing: you are no longer operating as a responsible, prudent Founder CEO. However, I also think that a Founder CEO who becomes fixated on the economy and the markets is also being pulled off task from leading an operating enterprise.”
Preparing to raise investment during a downturn? Investors urge founders to focus on storytelling, selling narratives that numbers cannot and preparing to answer to the tough questions.
The downturn has signalled to founders the need to create options for the future and increase flexibility in business strategies and behaviours, including ways in which they prepare for raising investment. We asked investors to give founders top tips for raising investments during this time.
Aloor, of MATR, has described the importance of telling a compelling story and connecting with investors, especially when money is tight. Aloor says storytelling has been and will continue to be at the heart of a successful start-up pitch:
“Story matters, connecting with your investors matters. Trying to get them to understand what is it that made you the founder? What is it that prompted you to start this journey? Connecting with your funders is especially important here.”
Graham, of Phoenix Fire and The Firehood, acknowledges this saying storytelling narratives will get you places numbers cannot always. She urges founders to put forward an extra unit of effort and increase communication with investors.
“You really must be a true leader. It puts pressure on emotional intelligence and true leadership. Using the storytelling narratives, pictures, images, and visuals, icons, and charts to highlight your story to a potential investor in an effective way could sell a much bigger story than the numbers at this point.”
But founders’ pitches are only half of the equation. With funds not being as accessible as they once were, investors will be asking the tough questions and founders’ answers will begin to differentiate those who will stand out from those who will not. Sarkar, Advaita Capital, reports seeing many founders that are unprepared to answer questions effectively, showing a lack of calculation and homework. She gives examples of questions that investors are typically ill prepared to answer:
“They are not prepared with the questions that the investors are going to ask like, what is your operational risk, what is your churn rate, what is your LTV: CAC? What is your growth, 5x 10x? What is your net revenue, CAGR? What is your burn rate? What is the total market, broken down by segments?”
For minority founders who, historically, have not had the same level of access to funding, the downturn can pose more of a challenge. Know who you are pitching to and create a supportive network.
Female and racialized founders are met with a trickier situation compared to most during this economic slide. With an already limited access to funding, female and BIPoC founders are struggling to stand out and survive amongst the rest.
Aloor, of MATR Ventures, says picking your funders is critical to having a both a successful and enjoyable journey. Match yourself, your company, your product, your values, and your future with investors who will support and guide you will be a major factor in survival. Aloor advocates for female and racialized founders to focus on funds that primarily work with underrepresented groups:
“Know whom you are pitching, know from whom you are going to ask for money. Getting to the right person, the right group of people can make that journey as a start-up founder so much easier for you than if you went to the wrong group of people.”
Zimmerman of Reinventure Capital, a firm who invests exclusively in US-based companies led and controlled by BIPOC and/or female founders, explains why attention should be paid to female and racially diverse founders:
“During those two years and change of record-breaking amounts of capital flowing into the venture and private equity sectors, and record-breaking quantities of capital being invested by the venture and private equity sectors, the percentage of capital going to female founders and founders of colour did not appreciably improve. In fact, in some instances, it decreased.”
Zimmerman highlights the importance of networking and connecting with partners and firms who are focused specifically on minority founders. Reaching out to a peer network gives an opportunity to gather invaluable candid, actionable insights, Zimmerman says.
“If you are a Founder CEO, for example, in the first year of operating your enterprise, reach out to a Founder CEO who’s 18 to 36 months ahead of you in a similar enterprise: someone who understands the sector you are in, someone who understands the path you are on. Ask their advice. What have they seen? Who has been helpful to them? What lenders have they spoken to, what investors have they spoken to? Who was helpful to them? What did that look like? What other resources have they turned to? How are they thinking about the experiences they had at your stage? And how are they thinking about what they are going through at their stage?”
During this downturn, become the company that’s fundable!
Will this downturn evolve into recession? And how long will this last? The responses among investors vary. “We cannot predict the future and we cannot predict the market.” (Sarkar) This rude awakening may be merely a “contraction” (Aloor) in an otherwise normal market cycle. Most investors agree that companies living through this downturn “will find what a company needs to look like to be fundable is going to return to what is a more normal venture capital expectation” (Speakman). In the meantime, this is a time for founders to regroup and re-evaluate the components of the business that will extend their runway and allow them to accelerate product development, while being conscious of expenses. This will be a true test of “creativity, true leadership, emotional intelligence” (Graham), and revealing how “nimble and resilient” (Peltz-Zatulove) a founder can be. Have the focus but be the “number one passionate person, that crazy person who wants to get this done” (Opala). Founders who balance this with “the burden, responsibility, and privilege” (Zimmerman) to lead their team through this crisis will be the “cream that rises to the top.” (Aloor, Speakman)
About Taylor McAuliffe
Taylor McAuliffe is a 4th year student at McGill University studying a major in Industrial Relations and double minor in Economics and Communications. Her work experience centres around content creation and copywriting. She currently works as the Interactive Media Writer Intern at Altitude Accelerator.
About Altitude Accelerator
Altitude Accelerator is a not-for-profit innovation hub and business incubator committed to commercializing impactful technology in Southern Ontario. Altitude’s team of more than 100 expert industry, academic, and government partners and advisors helps start-ups in cleantech, advanced manufacturing, internet of things (IoT), hardware, software, and life sciences grow faster, stronger, commercialize their products, and get to market. Headquartered in Brampton, Ontario’s Innovation District, Altitude Accelerator was created through a partnership with the University of Toronto Mississauga, the Mississauga Board of Trade, and the Ministry of Economic Development, Job Creation, & Trade.