8 factors to consider when fundraising during a downturn

These are challenging times, but this is not the first time I have heard that.

This year brought the first signs of skepticism and pressure on venture. In the past decade, we lived through an unprecedented run of optimism and climbing valuations, and the gut check we’re seeing now has been long in coming.

I have experienced two major financial disruptions in my career: the bubble burst in 2000 and the financial crisis of 2008. I ran a technology startup and a fintech startup through these times, respectively, and as such I have experienced the impact that such events can have.

The key difference between 2022 and previous downturns is that this contraction was anticipated for a long time, whereas the previous downturns were far more sudden. Markets have reacted, and valuation multiples for both public and private companies have been heavily compromised, leaving growth investors in fear of losing the opportunity to secure targeted returns.

Growth investors have become far more reserved when making new investments, and many are redefining how they approach valuations. Investors will likely remain on the sidelines for the most part as the markets settle and a new set of comparable multiples has been established. This might take a little time.

Similar to how public valuations impact growth investor returns, earlier-stage investors have also been heavily impacted. As an early-stage investor, we are always looking for a company’s path to eventual exit and the associated valuations. The most important next step is to secure growth investment, without which many startups won’t survive.

Early-stage investments are also tightening, as investors focus on lower valuations that accommodate revised paths to an exit, and on business health, which is now becoming more important than growing at any cost. The tightening of the public markets essentially has a domino effect that ultimately makes it harder for startups at any stage to secure capital.

It is more important than ever for founders to remain calm and be strategic. At M13, we have some thoughts about how founders should think about the market and their options as they navigate this period of volatility.

Below is a series of considerations that stem from both my direct experience in times of austerity as well as what we’ve learned from our existing portfolio today:

Investing timeline

Founders must consider a new timeline for the investment process. Last year, we would recommend reserving three to six months for fundraising, but we now recommend that founders plan for a six to nine month process for each round beyond early pre-seed.

Valuations and dilution

Founders should also be open to new considerations around valuations. The comparable valuations from last year cannot be supported today, and expectations should be managed. Dilution will be more of a concern and could drive a founder’s desire to raise less capital. This ultimately leads to more frugal post-funding strategies.

Runway

We recommend that companies secure 24+ months of runway with any fundraise today. More financial breathing room is important to ensure the company is not in constant fundraising mode, limiting its ability to execute. With previous considerations in mind, strategies and budget are incredibly impacted.

Performance expectations

Despite these limitations, companies cannot coast by. You have to stand out from the crowd more today than six months ago. In an effort to build a more conservative budget, the biggest mistake would be to cut yourself off at the knees and threaten your ability to execute.

Founders still have to exceed their goals to ensure the best chances of further investment. Startups need to truly stand out in their category to ensure interest from downstream investors.

Ruthless prioritization

An exercise we run with most founders at M13 is defining the proof points that need execution to facilitate the next round of funding.

Founders have to go in with a plan and ensure their budget allows them to meet this plan efficiently with minimal fat or wasted resources or initiatives in the process. Founders should consider a big brush analysis of activities that may not be optimal at a time like this. Focus on specific initiatives that drive toward defined goals, and ruthlessly de-prioritize those that do not have a direct impact on business targets.

Negotiating rent and other services can help, but the impact to cash flow will be nominal. To truly extend runway, founders need to begin by prioritizing core strategies that drive far larger swaths of the budget, and cutting those that don’t have a direct impact on the key goals for the next funding round.

Target revenue

Founders must focus on the growth that counts. Investors will be looking for targeted revenue that is tied to the business model and can scale over time. The key is to prove the business model, and this won’t work with alternative service contracts that might add short-term cash flow benefits but would likely distract from the core business strategy. Focus on the core model of the business, and prove that you can build a scalable revenue-generating business from that model directly.

Team motivation

This is where great founders shine. These times create a lot of pressure on a founder, but it is key that these pressures do not trickle down to the team. Even if some employees might be laid off, most startup teams will still grow before their next round. Retaining the best talent with excitement and engagement are imperative in these times.

Founders must maintain the excitement and energy around what they’re doing. This is not the end of the world, and founders are still building great companies, and challenges will always remain consistent. Rally the team: This is the time for all to come together and build the great companies that have been envisioned.

Focus on next funding

Although it is always important to have a vision for the long-term goals of the business, this is a unique time. The most important goal in this time is the next funding round. This means that sometimes you have to sacrifice longer-term investments for shorter-term goals until the company is sufficiently funded to support the greater vision.

We are living in a unique time where founders will need to walk a fine line between conservative budgets and aggressive performance. The key is to say stay focused, prioritize ruthlessly and make sure your A-team is locked in for the ride. We will all travel this journey together, and I expect we will emerge with some great innovations and businesses that will shape the future.