Over the last two years and certainly up to the end of 2022, more than three-quarters of European VC backed companies that went public since the beginning of 2021 are trading below their IPO price. In fact, 2022 saw the fewest public offerings since 2019 and that's interesting. The market for initial public offerings (IPOs) is smaller in terms of number of deals done, and even among those IPOs that did get done, more than three quarters of the issuers are trading below their IPO price.
Be ready for uncertainty
There are a lot of people who are going to bed at night thinking that the value of their non-listed startup or emerging growth company (or portfolio of same) is higher than it really is. What can you do about that? You can mitigate a horrible situation when it comes to valuation by cutting your burn rate(s) and extending your runway(s). If you can raise more money, even on the same terms as two years ago (or even at a slight discount), it is wise to extend your runway(s). Because the last thing you want to do is run out of money. That's when you are surely most likely to find the nadir of your valuation range.
The data suggests that market headwinds – the difficulties and factors affecting the market – are essentially the same as they were in during the last three quarters of 2022. That includes the war in Ukraine, which creates uneasy political uncertainty. Inflation and interest rates are other important factors, along with global supply chain challenges – although the last one is rapidly easing after the Covid pandemic. A consequence of the the latter challenge, however, is that the whole world is looking more carefully at locally-sourced materials rather than being dependent on, say, China to be the sole or primary supplier. On top of all that, the emergence of spy balloons and "Unidentified Aerial Phenomena" (UAP) (fka "unidentified flying objects" or "UFOs") over North America the last two weeks is making a lot of people all over the world wonder: "What's up"?
Good news, but be patient
The good news for early-stage companies is there's a lot of dry powder. The financial markets have stuffed record amounts of money into professionally managed Venture Capital and Private Equity funds, and that money must be deployed, sooner or later. The general partners of these funds get paid handsomely to put that capital to work – they earn a management fee based on assets under management (generally, 2% per annum), and carried interest on realized returns (subject to return of capital, generally, 20% of capital gains) (the so-called "2 and 20 model"). So, these folks cannot just sit like fat cats on a heap of dry powder indefinitely, or their limited partners will, rightly, ask why they are paying management fees on idle capital?
We were at the recent Web Summit in Lisbon (November 2022) and a lot of people on panels who work with many different accelerators in many different markets were in almost unanimous agreement on one change in the market for pre-seed capital. The days of the “founder-priced party round” are over. Unlike the founder heyday (from 2019 up through Q1 2022), when any cocksure pre-seed founder could simply say “Hey, we’re selling a SAFE with a cap of [you name the high end of the $$$ range] and you must act quickly or you'll miss the boat, because we’re likely to be oversubscribed within a week or two…”, well, that's not happening very often anymore. Investors are doing a lot more due diligence and spending a lot more time to go through the valuation, deal terms, pro forma financials, and reference checks. FOMO no more.
Innovation is still happening, of course, especially in the artificial intelligence and information security space, but we think that the volume and the velocity in the fundraising landscape is going to continue to be extremely challenging for the balance of 2023. Great entrepreneurs and teams can and will, absolutely, still attract capital. There's plenty of dry powder out there. But it's going to be harder and it will take longer to manage the process from beginning to close. Further, we think the valuations and the deal terms will also continue to be tougher from the perspective of founders and venture management teams.
Batten down the hatches! Time to get to work
As both startup and emerging growth companies start to run out of runway, several challenges present. First, many will not have the liquidity and capital resources to invest in innovation or growth, so now they have to be more conservative on one or both fronts. For those truly strapped for cash, they must begin to consider strategic alternatives, such as a sale of the company, or even an "acquihire" transaction. It’s not easy to get these deals done because of potentially incompatible cultural issues, founder egos, and broken cap tables. Note that all of those issues also tend to generate additional cash burn in the form of legal fees. For some leaders and teams, the process may bring on a sense of vertigo, like water swirling before it goes down the drain.
By the time the venture finance market fully bounces back again, we predict that there will be more carnage in the startup and emerging growth company space than what we saw during the DotCom bust years just two decades ago. As the great American humorist Mark Twain once quipped: "History does not repeat itself, but it does rhyme."
One of the things startups and founders can and should do now is onboard one or more competent and experienced venture finance advisors to help sort out the various pathways that may be available for your venture and your team in the current market.
At this point in time, our general advice is simple: "Batten down the hatches!"
It's time to be brutally honest, disciplined and objective. Although you may think this exercise is simply "business as usual", it is not. This may be a once in a generation challenge and opportunity for both you and your team.
Focus on your strengths. Keep only the most essential contributors. Stop doing things that are not absolutely necessary. Continue doing things that are essential to your value proposition. Start doing things that will enable you to develop a long-term competitive edge.
This will not be easy. You may need to cut people, and projects and initiatives. But it will provide you with clarity and focus and more runway.
If all else fails, we suggest you figure out how to go into hibernation until "Winter is Over". In other words, whatever happens, your last best bet is to "live to fight another day".
Time to get to work.