Market Update - Q1 2023

Venture Market Update - Q1 2023

State of the Seed Market

The seed market re-opened in Q1 of 2023. Deal velocity is slower and some firms haven’t fully re-entered the market, but deals are happening.
Valuations have corrected. The typical round right now is 4M on 16M post. (In 2021, it was often 3-5 on 25). Founders are okay taking a bit more dilution (25% instead of 20% at seed) in exchange for 24 months of runway.
Seed specialist VCs are typically writing slightly smaller cheques, for slightly higher ownership, but also keeping more cash as reserve for follow-ons. They’re doing the latter because multi-stage VCs aren’t yet back in the market.

State of the Series A Market

Series A remains very slow. Some deals are happening but they’re few and far between. The crossover and multi-stage funds have pulled back, and that removes FOMO for the A-round specialists, who can take their time observing and diligencing.
Limited data points, but the typical round right now is 10-15M on 30-45M pre. They say 1M ARR hurdle, but I suspect that most startups getting funded are a bit beyond that – 1.5 to 2ish. So we’re looking at a 15x to 30x ARR multiple.
That’s down a lot from the 100x seen in 2021, but it’s still above the 7x seen in public market comparables. Obviously, publicly traded SaaS cos are much later stage and so growth is much lower, but still – either the public multiple has to expand to say 10x, or the A multiple has to contract to say 12x, for the market to equilibriate. This imbalance is why the A market is currently gridlocked.

Efficient 2x or Inefficient 3x?

24 months ago, the mantra was “growth at all costs” – a blue chip VC told me, we don’t even look at deals below 3x yoy growth, and 5x is better. Today everybody says “we want efficient growth”. But is that really true?
Empirically, the answer seems to be “neither”. Companies growing 3x but burning a lot are finding it hard because the VCs know that those companies will need more capital in the future, and that capital isn’t currently available. Companies growing 2x but more efficiently are also finding it hard but for a different set of reasons – there’s no FOMO so VCs now worry about TAM and trajectory and PMF.
If I had to choose, I’d probably pick slower growth with the potential for profitability. That way you control your own destiny: you’re not locked into a “mandatory” fund-raise 6 or 12 months from now.
To keep the door open for future rounds, try not to fall below 2x yoy – this is the widely accepted dividing line between “high-growth” and “zombie” companies (there doesn’t seem to be anything in between). Also, if you can show that you have ability to grow a lot faster (than your current “efficient” level, whatever that is) with additional capital, then that’s very helpful.
Of course if you’re growing at 5x yoy in a hot market, then all of this is moot and you’ll likely be able to raise. Unfortunately most of us are not in this fortunate situation.

Thoughts and Recommendations

(strategic) In the current market environment, you can’t count on a Series A even if you do everything right. Things could get better over the next 6-12 months, but they might not. So on balance, this suggests putting more weight on a “plan B” – a path to profitability, where you control your own destiny. Don’t be “Series A or bust”.
(strategic) When capital is cheap, it makes sense to follow the “venture trajectory” – raise large rounds and spend to grow. This also enables business models which depend on financing to get off the ground. But when capital gets expensive (e.g. right now), it’s worth thinking about whether the venture trajectory makes sense for your business and also for you as a founder. There’s a lot to be said for growing at a steady rate, staying cash-efficient, and not diluting, especially in today’s choppy market.
(strategic) The danger scenario is the messy middle – companies who are growing okay, with okay efficiency. In a “normal” venture environment (say 2015-2019), these companies will get funded – maybe not by a Benchmark or a Sequoia, but by someone. Today, that’s not happening. If this is you, take action now. It’s hard to magically kindle growth, so maybe the action is figuring out how to get to breakeven with the cash you currently have. Maybe raise a bridge round; maybe cut costs. 6-12 months of runway suddenly feels very limiting.
(tactical) Be wary of meeting-itis. Deals aren’t being done but VCs are taking lots of meetings “to get to know you”, to track your progress, hear your story, map the market, whatever. Be very disciplined about this – do not mistake an inbound inquiry for actual investment interest.
(tactical) Be wary of vultures and bottom feeders and opportunistic investors. There are funds who are writing very predatory term sheets (low valuations, preference multiples, lots of structure and control) to companies who have no choice. And there are late-stage companies who raised a bunch of cash in 2021 but don’t have the metrics to back that up, who are aggressively trying to acquire early-stage startups “on the cheap” in order to juice their own growth.

Added: State of the Series B Market

Added new section on Series B. I’m less familiar with this market than with Seed and Series A, so there’s less data to back this up; please weight my observations accordingly.

I’m seeing a few patterns at Series B:

Growth investors are bargain-shopping ie looking for cheap deals and offering aggressive terms. This includes a lot of mid-market PE firms who now have a clear thesis: “Many of the high fliers of 2021 will become zombies – 2 to 10M ARR growing 0-50% yoy, but not profitable – this isn’t enough to raise further venture capital. This creates an opportunity for us to acquire them at 2-5x revenue, cut costs aggressively, maybe roll up a few adjacent firms, and then sell for 5-7x revenue in a few years”. Often, zombie companies have no choice but to accept their bid, because they have no cash and their VCs can’t or won’t bridge them.
Some of the startups that raised really big rounds in 2021-22 are now planning to make that money last 4-5 years (which is historically unprecedented). They’re not spending aggressively on growth; instead they’re hoping that their revenue will grow organically to the point where (a) it offsets their burn = infinite runway and (b) it justifies their valuation.
I’m seeing a fair bit of “tuck-in acquisition” – a PE firm or growth equity firm acquires a zombie company OR they have already put money into a high-flier; now they desperately need to juice growth; so they’re casting a wide net looking for early stage (pre Series A) startups that they can bolt on to the existing business. I bet some of you have already fielded such inquiries.
Zooming out, the IPO window remains closed. Until that window reopens, it’s very hard for the late stage market to clear at “long-term rational” prices; instead you get all this kind of reshuffling and structure and game-playing.
My best guess is that the hurdle for a decent Series B remains 3-5M ARR growing >100% ie >2x yoy. But with a heavy weight on profitability / runway, because of these game dynamics – the best way to raise money is to show that you don’t need it.

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