There has been a great deal of change over the past year and a great deal of turmoil that is having a significant economic impact. We are seeing the implications everywhere from the gas pump to the grocery store to Wall Street. Therefore, it’s not surprising that all of this is impacting startup valuations and venture capital funding, creating an environment that is in stark contrast to what we were seeing just seven months ago.
Anecdotally, the market is whispering the heightened focus on operating expenses, time to market, traction, churn, and ultimately, profitability. The days of funneling cash into a fire of growth is no longer du jour, as valuation multiples are increasingly based on profitability in addition to growth. With the cost of capital looking to rise on all horizons, the premium on profitability is rising, and the focus on growth at all costs is tapering.
According to Crunchbase data, global venture funding in May 2022 was $39 billion (with a slowdown in the latter two weeks of the month). This was the first month in more than a year to see funding below $40 billion, and it is well below the November 2021 VC funding peak of $70 billion. Crunchbase also notes that there was a 14% drop in VC funding between April and May, and funding is down 20% from May 2021 to 2022. They point out the largest pullback was in late-stage venture capital, but that seed funding has remained robust.
So, what does this mean for venture capital investors, and what does it mean for startups? It means that deal terms are becoming more investor friendly, with lower, more normalized valuations going back to what we were seeing prior to 2021.
It also means investors are starting to build more valuation enhancements into deal terms, such as
We are also seeing investors attempt to protect their downside with:
In early stage pre-seed and seed-deals, where investments are often documented on Ycombinator-driven forms of “simple agreement for future equity” or “SAFE”, we are seeing investors demand certainty in the form of a side letter:
In web3 startups, we are also seeing the investors make special requests, such as:
While we are seeing some flat rounds, we are not yet seeing down rounds, although one can expect to see a significant uptick in the latter half of the year if current trends continue. If you have the luxury of taking a priced round or a convertible note or discounted SAFE, at least consider whether you wouldn’t be better off with priced round at current valuations.
The good news is that in our work with hundreds of emerging growth companies at all stages of growth and their investors, one thing we are not seeing a freezing up at any stage of the market. We are also not yet seeing a degradation of enhanced founder-friendly control rights, which became prevalent in recent years.
Money might not be flowing into startups at the rate it was last year, but it has not stopped. It is important for startups to continue to make smart business decisions and to avoid jumping into deals that aren’t smart for them in the long run and making hasty decisions out of panic.
Extension of equity rounds priced in the past year with additional equity or venture debt can be an alternative to trying to raise a new round of equity or simply an extension of runway to better times ahead.