We have all heard the Rolling Stones classic, “You Can’t Always Get What You Want,” and in 2023, the song has new meaning for startup founders. Pitchbook recently released their analysis of the current imbalance between the capital startups want and the money that VC firms are investing. Here is what they found:
There was a significant imbalance between the demand for capital and actual investment in Q4 of 2022, with their analysis showing demand outpaced supply by over 145% in some instances. They found that in general, there was twice as much demand for capital than what was supplied in that quarter ($42.8B more in demand than what was supplied).
Where was the greatest imbalance? While this is impacting startups at all stages, their data shows it is having the greatest impact on later stage startups. Their breakdown of demand outpacing supply shows early stage at 50.5%, late stage at 148.5%, and venture growth at 67.1%. In fact, they show early stage as the only stage with a Dealmaking Indicator still more startup-friendly than its pre-pandemic level. This is not surprising as we discussed in a previous blog post where we demonstrated why Series A funding has seen less of a slow-down overall than funding at later stages.
So, what does this mean for startups and investors? It means we are in an investor-friendly environment to say the least. Investors can be much more diligent about where their money is going, taking their time to find those startups they feel have the greatest chance of success. They also can demand much more favorable deal terms, leaving founders with fewer options for negotiation.
This is something I discussed with The Information last fall, noting that in 2022, investors were receiving much more favorable deal terms than in 2021. At that point, I told the publication that two-thirds of middle- and late-stage startup deals I worked in 2022 had a 2 to 3 times liquidation preference, meaning those investors would be paid back double or triple their money before other stakeholders. This is a trend that is likely to continue as we move through 2023, so it could be a prime time for investors looking to offload some of the dry powder that is piling up at record amounts.
As we move into February 2023, the new hurdle for venture capital funding for an enterprise SAAS software business is $2 million in annual recurring revenue, when last year the hurdle was $1 million in ARR.
Startups still have options, and there is funding available for those who can meet these high-performance hurdles and satisfy new levels of investor due diligence.
The only thing that is permanent is change, and the pendulum will swing back again, but for now, startup founders should know the new rules of the road.