Startups: postpone your next fundraising until at least Q4 2020… if you can.
The first quarter of 2020 has brought an unprecedented challenge for most young startups: the coronavirus crisis, the following economic downturn and the likely prospect of an economic recession to follow. In the last eight weeks, I’ve received an unusually high amount of requests for introductions to investors from startups in my network and our portfolio companies. The biggest outtake is that they are struggling with their current financing round, due to sudden need of cash and/or the prospect of the difficult outlook ahead. These requests led me to share what I see in the market and to provide an honest reality-check.
The fundamentals of growing a startup and why this upcoming period can be a sizeable challenge to overcome
Most technology startups are constantly fueling their growth with external capital to achieve scale, develop a sustainable business model and acquire significant market share. Even if a startup can achieve profitability with its current recurring revenue, almost every startup aims to boost their growth by investing in people, tech, product/service. To execute that growth strategy, it is recommended to raise enough money for a period of 18 months. Generally, the CEO of a tech company would start the fundraising process once every twelve months, ensuring there is still another six months of cash available to close a round of financing.
The current global economic environment makes it very difficult for an early-stage startup to follow the above-outlined financing strategy. It becomes very challenging to raise subsequent financing from other than already-existing investors.
For almost all startups, the upcoming period will be difficult and will require perseverance and adaptiveness. For most startups, it will be a period full of dissolutions where plans are shattered, and for many, it will mean the end of the startup adventure.
Some evidence of the severity of the situation
Looking online, you will find lots of insights about the severity of the situation. In this post, I’ve decided to share first-hand indicators on how we have seen the situation has changed for some of the 200+ startups in our portfolio.
Below I’ve outlined three cases from our Rockstart portfolio as indicators for any startup founder who might still be doubting whether to start fundraising for the next round.
Indicator #1: SaaS company raising their ~€4m series B from a strategic investor. The term sheet was set to be signed the first week of April. The corporate strategic investor postponed the deal until the situation has normalised (unknown timeline).
Indicator #2: B2B Enterprise software company had a term sheet for a seed round. The valuation dropped ~30% overnight after the lead investor reassessed the market opportunity.
Indicator #3: B2B hardware company had to take an immediate ~40% down round from existing investors after failing to commit a new lead investor for the upcoming round in time.
And the list goes on….
This happens across the globe and at all stages of a startup’s lifecycle regardless of the amount of traction the startup has achieved.
Only startups with a clear lead investor, a term sheet or agreed terms will find it possible to close a financing round. We have seen a startup closing a round last week as the terms were agreed upon already at the beginning of Q1, and they have strong commercial traction. Most startups that are starting their fundraising process now will have an incredibly difficult time to raise financing in Q2 — most probably in Q3 and even Q4!
The investors’ perspective on this crisis
As a startup founder, you might be baffled how conversations can change that rapidly. In short, the risk profile for investors has changed quite significantly due to the a) lack of market opportunities for startups, b) the need to (re)finance and support investor’s own portfolio, and of course, the opportunity to c) wait it out and invest in the survivors.
a) Lack of market opportunities for startups
In a thriving economy, a reasonably good startup has a fair chance to raise the capital it needs to achieve traction to raise the next round. In a down market or even a recession, most potential customers are going into a defensive mode with hiring freezes or no-new engagement policies. Although the product or service can be highly relevant, it could take up to 12 months before potential clients will be able to take the risk on a new product or service. As all startups are geared towards growth, this poses an obvious problem. In this new environment, the number of startups that have a chance to be successful will be lowered: only the ones with proper commercial traction already, a recurring business model, sufficient cash on the account will be able to manoeuvre through this period.
b) The need to (re)finance and support investor’s own portfolio
With the sudden change in the macroeconomic situation, many startups will need to restructure and re-strategise to get through these difficult times. This will require an immediate need for capital and management support. This is not an attractive situation for a potential new investor. It is therefore expected that existing investors will need to make an assessment whether they still believe in- and are willing to further finance the company. In case further financing by existing investors is not achieved, it is also unlikely that a new investor would be interested as the current investor has all the information needed to make a decision to further finance the company. These dynamics force investors to focus on their existing portfolio which means that almost no investors will be looking for new opportunities.
c) Waiting it out and invest in the survivors
During the economic upswing which we have been experiencing for almost ten years, investors have been battling to get into the best deals. In a situation where the economy is doing well, many startups will look attractive, will manage to get some initial traction, and easily attract investors. During an economic downturn, there is less competition to get into deals, and investors who are looking at new deals, are likely to wait and see which companies in their pipeline will survive and how the market will develop.
For the existing investors in a startup, the most pressing situation at hand is to avoid losing the money they already invested in their current portfolio, which means that this will be their primary focus and attention.
Postpone the start of your next fundraise until at least Q4 2020
Looking at the information at hand, starting a fundraising process right now has a very low likelihood of being a success. Even if a startup is able to succeed, expect 30–50% lower valuation than expected.
I would suggest postponing your fundraising process until Q4 2020 with an expected closing in Q1 2021. If you want to ask for financing from your existing investors, make sure you prepare a conservative plan for the next 12 months and ask for a loan facility and/or bridge round for the amount that you believe is needed. You should expect that the macroeconomic situation might worsen during Q2 so now is the time to make a request for this — don’t wait.
If you do not have any investors interested, or the investors do not have the ability to support you through this period, make sure that you cut costs immediately and expand your runway to the maximum capacity. If you can not foresee how to get to Q4 2020 and ultimately Q1 2021, the reality might be that you need to consider how to liquidate your company without taking on a significant amount of personal debt.
On the contrary and on a more positive note, if you’re one of the startups that makes it through these difficult times, you’re in a position to become a market leader.
What to expect?
No one really knows what the coronavirus will bring. We do know that the fallout is heavily dependent on the actions governments take in terms of stimulus as well as how long lockdowns remain part of our daily life.
Here are some interesting perspectives worth reading on how things might play out: Understanding the COVID-19 Recession.
You can follow the development in as real-time as possible on this global COVID-19 dashboard delivering by Ravenpack.
