Fundraising guidance for founders
Last week, we shared fundraising guidance amidst recent market dynamics exclusively to all of our portfolio founders. We are now sharing our portfolio letter more widely in hopes that all founders will benefit.
Why we’re writing
Dear founders,
Today, we’re sharing an extra update looking into market dynamics and what they may mean for you.
On the public side this year, we’ve seen markets turn upside down and, as a result, we have started to see ripple effects into the private side. Even as an early-stage investor, we are spending a lot of time evaluating the current macro environment and wanted to share some guidance as you navigate the weeks and months ahead.
What we’re seeing
Technology continues to be hit the hardest.
With NASDAQ down 21% YTD, many publicly-listed technology companies are trading at steep discounts compared to their valuation highs. We’re also seeing fewer SPACs and IPOs, which are down near 50% quarter-on-quarter. Stock markets with elevated volatility levels (follow the VIX) have always been a negative indicator for new companies about to list on a stock exchange, which requires months of preparation and investor marketing. During times of uncertainty, investors typically refrain from committing to investments that are too far out in the future. In other words, any transaction on a public market with lead times of a couple of weeks or more, such as an IPO, will not satiate investor appetite.
We anticipate that private financing rounds will be impacted across all stages with smaller rounds sizes and lower valuations. This is due to tightening money conditions fuelled by strong inflation fears and geopolitical conflicts, such as the war in Ukraine. In particular, companies with publicly-listed peers will face significant headwinds when pricing their next rounds as investors refer to lower valuations and potential illiquidity discounts.
VC investments in Europe are likely to further slow down.
While we have not yet seen a significant slowdown in VC investments or rounds being repriced at lower valuations in Europe or in our portfolio, fresh Q1 2022 data from the U.S. shows what we are likely to expect in the upcoming months. Every stage, from early to late, was hit in Q1, with Series A capital investments decreasing as much as 58% compared to Q4 2021 (note however that Q1 is typically slower than Q4). While still up against Q1 2021, the new numbers show that — despite significant amounts of dry powder in VC funds — the trajectory of 2021 may not continue.
Valuations are likely to mirror inflation ebbs-and-flows.
VC funding, similar to many other asset classes, has benefited from easy money conditions in the past decade. Looking at the yield curve as a classic macro economic indicator over time alongside VC post-money valuations, we see a positive correlation with a certain lag time. A declining yield curve 2022 YTD may give us additional hints as to what we can expect for the remainder of 2022 with regards to additional investment into VC.
Unicorns are looking for capital.
At the same time, the ecosystem in Europe has seen a massive increase of new unicorns at a very fast pace fuelled by an inflation of later stage funding rounds, many of them without the necessary business fundamentals. Many of these companies will be out fundraising for new capital and, when easy money conditions tighten, fundraising will eventually become tougher due to less capital availability alongside valuation compressions.
What we’re advising
Brace yourself: Expect raising follow-on rounds to be more challenging in the next few months. This is independent of your business model and, rather, a reflection of the current external market dynamics. It is possible that these rounds will be smaller and at lower valuations than those we witnessed last year as early and late-stage investors reassess entry prices. Yet, that being said, we have seen financing rounds completing at 2021 prices in recent weeks, too. So, it simply depends on your company’s sector, stage, and, of course, your company’s growth.
Understand dynamics: This is not just a late-stage problem. Businesses of all stages and valuations are likely to be affected in some manner as investor appetite cools. But it’s not just founders or investors. Expect consumer spending — and new customer uptake — to decrease. Largely as a measure to combat inflation, central banks are raising interest rates. We’re already seeing this with the Federal Reserve in the U.S., which has just announced its biggest interest rate hike since 2000. As a result, the cost of capital, like borrowing costs and other prices, will rise, forcing many consumers to cut their individual spending. As this continues, B2C businesses will be first affected, but B2B may be affected in the midterm.
Assess offers: Consider raising additional capital if a serious opportunity presents itself as a measure to extend your growth. It may also provide the opportunity to regain market share as the climate begins to improve. Creating additional runway will position your company more independently from the external fundraising environment. So, don’t wait until raising capital is a “must” but rather a choice.
Review budgets: Take a fresh view at your budgets and cost structures — cash is king. Cut nonessential costs and expenditures, and look into renegotiating certain contracts. Also begin to sketch out alternative scenarios that can be ready to act upon if needed.
Carpe diem: Seize the opportunities in front of you. A bad climate can result in partnerships, M&A, and other scenarios that may not otherwise present themselves.
Don’t panic: Our most important point: don’t panic and stay focused. It will always be hard to time markets as an early-stage founder. At the same time, great companies will continue to raise. Act with a prepared mind and focus on what you do best — building strong companies with an outlook on the long run.
As a reminder, some of the best businesses are built in tough times. With that, please reach out if you have any questions and we’d be happy to set up a time to speak about this further.
Founders first,
Team Cherry 🍒
