Given the elevated risk profile of most businesses during a downturn, expect a greater amount of upfront diligence from VCs. To maximize the likelihood of attracting an investor who is aligned with your strategy, and actually capable of adding value, you should look to begin building relationships 12-24 months in advance of your process. This will help investors gain conviction around the business model and vision as they watch your company weather the storm.
While in a bull market, you can go from first contact to term sheet faster than your clingy high school crush went from first contact to “what are we?”, expect things to take much longer in a bear market. Over the last few years, intense competition in Silicon Valley has vastly accelerated fundraising cycles, with one well-known early-stage VC reporting an AVERAGE of 9 days to exclusivity. With less competitive pressure from other funds and compounded internal pressure from LPs to be effective stewards of capital, VCs will dive deeper into your data and look to gain more conviction around your model before making things official.
While private valuation is more art than science, it will be generally correlate to your scale, top-line growth, cash efficiency, and market valuations of comparable companies. During a downturn, you can expect your growth rate and ability to get to scale to be depressed, and while you may refocus on profitability (see below), you still are unlikely to achieve the same margins as you could in a bull market.
On the market side, public tech multiples are traditional benchmarks for private company multiples, though the former will generally command a premium given greater scale and liquidity. With the market quickly reaching the point where you could LBO half of the S&P 500 with an expired Dave & Buster’s PowerCard, it will be considerably more costly to raise the amount you’re looking for. If your favorite public comp is down 20% since the start of the downturn… chances are your prospective investors are revising their valuation models the same way.
While some investors accepted – and even encouraged – the above behavior in better times, the “growth at all costs” mentality is not sustainable during a downturn (and may not be sustainable in a good market either!). Expect to see attention shift toward companies who are measured and calculated with their investments and who have sound indicators around go-to-market efficiency like short payback periods and low churn. Companies with high burn – particularly if that is due to business model constraints such as high COGS – will find it tougher to attract capital given the scope of cost-cutting required to de-risk the investment.
Unless you’re sitting on the next Hooli, the days of mediocre VCs paying 15x forward-twelve-months ARR are behind us. If your previous investors were a little too optimistic in their projections, you could see a flat to down round, even if you still grew! The valuation you accept will ultimately come down to a judgment call on how you weigh dilution v. balance sheet firepower… if you’re sensitive about the former and your bottom-line is in good shape, you will have more flexibility to take on less capital than anticipated.
As growth investors become more oriented to downside protection, you will need to demonstrate the sustainability of your unit economics and ability to continue to grow with limited or zero cash burn. While this is more challenging in a downturn (see our guide to Your Budget in a Downturn), you can mitigate risk by focusing on current growth strategies and shelving more capital-intensive projects (e.g. expanding from Europe to the U.S.). Ultimately you will be grilled on your ability to grow sustainably – profitable on a unit economics basis is good, profitable overall is better – as this is THE biggest predictor of success in a downturn and correspondingly, your ability to attract the right investors at the right price.
Does that mean you can’t raise in a contraction? Of course not! But starting from a smaller base of prospective partners means it will be harder to attract capital. You may also find that the scope and timeline of diligence, as well as investors’ criteria, changes. Let’s look at the main differences:
With the proliferation of Corporate VC funds, venture debt lenders, and more white men in Patagonia vests than your average Kappa Alpha chapter, you probably thought the intro meetings with prospective investors would never end. While the longest bull market in recent memory has created countless venture tourists, many of them will retreat, tortoise-like, into their shells during a downturn for lack of experience investing in bear markets, or general fear about uncertain economic conditions.
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