Startups need to reset expectations when raising venture capital

This article originally appeared in Fast Company. Read the original here.

As we enter 2023, it is well understood that financial markets are presenting challenging conditions for start-ups. Venture capital firms only invested $36.1 billion in Q4 — a 63% decline compared to the same period a year ago, according to Crunchbase. I expect this pace to continue well into 2023, so founders need to have a clear roadmap if they’re looking to raise their next round this year. Since last spring, I’ve been working with our portfolio companies to prepare them for their next rounds. Here is some of the advice that I’ve given them.

A well-orchestrated fundraising process always begins with relationship building — and in an economic winter like the one we find ourselves, this is more important than ever. If you grew accustomed to rapid competitive fundraises in 2020/2021, it’s time to recalibrate expectations. Good preparation for raising funds today will involve months of pre-work to warm up investors in advance of actually going to market. This could mean taking the time to have multiple meetings with your top 20 target investors for your next round over a period of 3–6 months in advance of actually launching your fundraise formally.

Once you are approaching the time to formally begin fundraising, marketing materials are important. In today’s environment, this means the right combination of intro note, 1-pager, deck, and data room (with specifics of each determined by stage). These materials should present today’s market conditions as an opportunity to capitalize on by beating out less nimble competitors or taking advantage of other macro trends specific to your company’s focus area. It is worth honing these materials through multiple iterations well in advance of your fundraise.

When going to market, you may want to have a list of at least 50 (if not 100) target investors in order to ensure that you ultimately end up with multiple potential leads for your round. This ideally will all come from warm introductions from your network and existing investors to ensure you cut through the noise. Remember that many investors today are either not investing or have slowed down significantly and are seeing a large volume of attractively priced deals. It is going to take a special story to break through all the opportunities that are available to investors today.

Perhaps the most important adjustment to make to fundraising today is on valuation. Valuations have reset downward significantly — 20% for seed, 40% for Series A, 70% for Series B, and 80% for Series C. This means that you need to have realistic expectations for your upcoming financing. Even if you have hit your target metrics for growth, a flat round may be a big win depending on how overpriced your last round was. In short, the pricing of your round in 2020/2021 is more or less totally irrelevant to today’s price. If you approach investors without this recognition, you will turn people off and likely struggle to find a lead investor.

Once you have a number of investors interested, you of course need to move toward a term sheet. Though investor-friendly terms like liquidation preferences and preferred return rates are beginning to re-appear, it could be best to take a cleaner approach and just find a valuation that actually aligns interests — even if that means a down round and the need to issue new options to incentivize management. Creating complex structures has future consequences and it may be better to bite the bullet and truly reset to today’s market conditions rather than defer to that.

Expect the entire process to move more slowly. Term sheet negotiations won’t be instantaneous. Aligning the remainder of the syndicate will take time as well. And there will be more legal and formal diligence than in prior years. It is important to give these steps the time an investor needs while also maintaining forward momentum and alignment about a target closing date so that you don’t lose a sense of urgency to close. Frequent high-quality communication is crucial in this phase and continuing to generate exciting further developments can be helpful to ensure no hiccups.

It is definitely possible to still raise capital in today’s market, but you just need to be ready to spend more time, take more meetings, accept more dilution and check more boxes on diligence. It’s not 2021 anymore.

Prime Movers Lab invests in breakthrough scientific startups founded by Prime Movers, the inventors who transform billions of lives. We invest in companies reinventing energy, transportation, infrastructure, manufacturing, human augmentation, and agriculture.

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