Pitchbook recently released deal-level data looking at how investor-friendly or startup-friendly the current capital raising environment is. Their VC Dealmaking Indicator looks at various factors to create indicator values – the higher the value, the more investor-friendly the environment. A lower indicator value means a more startup-friendly environment.
Their data shows that starting mid-year 2020, conditions were more favorable for startups at all stages. Founders were enjoying higher valuations, with investment flowing more freely. However, there was a sharp change in 2022 that is continuing today. We are in a time of higher indicator values and a much more investor-friendly environment.
This means investors are in a favorable situation where they can acquire much larger stakes in startups. Another Pitchbook article examines the shift since the pandemic boom when investors accepted much smaller ownership percentages. Today, lower valuations mean investors can get a much larger equity stake for the same amount. Their data shows that “investors in the most mature companies have grown their equity stakes to a median of 14.9%, up from a low of 11.3% in 2021.”
This investor-friendly environment and increased level of ownership for investors has a variety of implications for both investors and startups. It can mean much greater returns for investors when there is an exit and more control and influence for investors. Startup founders should know this is not likely to change as we move into the new year, and they should be prepared to continue negotiating with investors who are in the driver’s seat.
Below are some key issues founders should consider when negotiating funding in today’s investor-friendly climate.
Have an In-Depth Understanding of your Financials and Business Model
Anytime you seek funding, having a solid understanding of financials, including revenue projections, burn rate, and key performance indicators, is critical. Still, when funding is harder to come by, this becomes even more important. Today’s investors may place a higher value on companies with strong financial fundamentals even during a downturn. Founders should be prepared to discuss, in great detail, their proposed use of funds and the expected milestones it will help to achieve.
Startup founders who can raise money from customers in multi-year deals or source government funding will do better than those who ignore these levers.
More Investor Control Means a Need for More Compatibility
If an investor is going to have a larger stake in a startup and, in turn, more control and influence, it is vital to make sure that both parties see eye-to-eye on the vision for the company. This includes the day-to-day operations, future goals, growth plans, and exit strategy. It is easy to want to jump on any source of funding when it is hard to come by; however, ensuring you are jumping in with a partner with whom you are compatible and have shared goals is critical.
Utilize Your Legal Team and Outside Advisors
In an investor-friendly environment, founders need to work closely with their legal counsel and outside advisors to ensure that the terms of the deal are fair and well-understood. When the terms favor the investor side, founders must protect their interests and negotiate a deal that is fair for both parties. Your legal team can help you understand the often complex legal implications of the terms and conditions and ensure they align with your long-term goals.
This is cyclical, and at some point, the tables will turn, and we will be back to a time when startups are in control again and valuations are on the rise. Then, of course, it will inevitably shift back to the investor side. Founders should have a firm understanding of operating in both a startup-friendly and investor-friendly environment to prepare them for any conditions.