Wednesday, May 22, 2024

Lesson #360: How to Survive a Difficult VC Funding Environment

Posted By: George Deeb - 5/22/2024


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CB Insights, a leading research organization that tracks venture capital financings, recently released its report on the state of the venture capital market in 2023. The long story short is: it was a terrible year for raising capital. The global market was down 30% year-over-year, to its lowest levels in six years. The U.S. market fell to its lowest levels in 10 years, down 21% in the last quarter alone. Gone are the days of “unicorn” creation (companies worth more than $1 billion), mega-sized financings, and excessive valuations. And, investors simply can’t exit the investments they have already made, with an anemic IPO market. A pretty bleak picture if you are a startup raising capital today. So, what are you supposed to do to navigate these choppy waters? Buckle up and read on, for some useful tips based on my past experience surviving markets like these.

Step 1: Batten Down the Hatches—Cut Expenses

Don’t fool yourself into thinking your story is better than all the others, and that you will have no problem raising capital. Once VC’s put their heads in the sand, it is pretty much across the board, with a few exceptions if you happen to be in a hot market like artificial intelligence, fin tech, retail tech and sustainability. So, that means you need to get your expenses down to the absolute bare minimum. And, yes, that most likely means making the tough decisions of downsizing your staff, to survive the storm.

You need to hunker down to focusing on your core business (no side projects) and most profitable product lines, remembering that your marketing efficiency during a down market will also be negatively impacted. So take out your hatchet, and start chopping away at all non-core and discretionary expenses. And when you are done, if you do not have enough cash on hand to survive the next 18-24 months without requiring any additional financing, you have not cut enough. Keep cutting until you get to that point, even if it means you are cutting into your “flesh” at that point. Because if you don’t, you will never live long enough to survive and fight another day, which is the primary goal of this exercise.

Step 2: Revise Your Business Plan for a Downside Case

If your original business plan was to grow 50% per year, spend unlimited marketing dollars, add many new product lines, and expand into new markets, forget it. You will need to table that plan and dust it off in a couple years. For now, you are in survival mode. Focus, focus and more focus is what is needed right now. And whatever assumptions you made in your original plan, cut them all in half. Your cost of customer acquisition will double in a down economy, which means your revenues could cut in half of where they are today. So, focus more on getting additional revenues out of your existing customer base, where you can. And, if you do not have any revenues from a specific initiative you are working on today, those should get zero attention in this market. Only focus on your highest revenue producing product lines, and double down on those.

Step 3: Talk With VC’s to Learn Their Revised Goals and Keep Networking

Just because investors are not writing as many checks, does not mean you stop speaking with them, as they are still sitting on a lot of “dry powder” of un-invested capital. But when you approach them, instead of raising capital and asking for cash, you are asking them what they are looking for in the limited investments they are making today. And, getting their reaction to your revised business plan to see if you are heading in the right direction or not. If they give you any constructive feedback or suggest pivots, listen to them, and consider taking those actions, if it will help you raise capital a couple years from now. And once you and they are on the same page, and you have set some reasonable goals for yourself, keep in touch with them and hit those goals. VC’s are still prefer to invest in the best teams over the best ideas, and if you can prove that you accomplished the goals you set out for yourself, a year after the fact, you will earn a ton of credibility with them for when you re-approach them for a capital raise once the markets improve, and you have over a year of relationship-building with them under your belt.

Step 4: Seek Alternative Investors Outside of Venture Capital

If you have cut all you can cut out of your expense base, and there is still a capital need, you will need to seek alternative investors outside of the traditional venture capital industry. This could be friends and family, angel investors, crowdfunding, venture debt, credit cards, asset backed loans (e.g., securing inventory, equipment, real estate), revenue share loans, home equity loans, etc. Time to pull up your bootstraps and get creative in your potential funding paths. But focus on equity investments, if you can. If you go down the debt path in a down market, it could end up being the noose around your neck, tightening with each month that passes.

Step 5: Think Out of the Box

If the venture capital market is closed based on a flight to higher quality investments, maybe the private equity market is still open for larger businesses raising capital. Maybe consider rolling up a bunch of companies into one bigger business that is more of the size that private equity investors like. For example, the VC’s may not have liked your $1MM profit business, but if you merge with four of your same-sized competitors, the PE investors may like your $5MM profit rolled-up business. There are creative ways to enable those “mergers” in a cash-free way, based on pro rata revenues or profits, and then help those additional shareholders get an exit down the road, when raising PE capital. Roll-ups are a pretty complicated topic, so get some help if you decide to pursue this path. This article I wrote about roll-ups may help you.

Closing Thoughts

When the venture capital markets close, it is critical to take actions like the above to ensure that your business does not close, permanently! Make the tough decisions now, to live and fight another day. Your current shareholders and future version of your business, built for the years that follow, will thank you.

For future posts, please follow me on Twitter at: @georgedeeb.

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