It’s no secret to early-stage founders: the startups funding landscape is different today than it was even a year ago. With funding harder to come by in a relatively less stable period for the global economy, venture capital firms are looking more carefully at startups before determining who gets the green light.
There is a strong silver lining to all this, though—not only are there still funds to go around, but establishing good business practices in leaner times can better position startups for future growth and success.
Learn more about the funding environment and top VC firms’ advice for thriving through it all.
The situation: Startups funding 2023
“Startup funding squeeze reaches the SaaS model,” a June 2022 S&P Global Market Intelligence analysis, describes 2021 as “a year characterized by easy money, and lots of it.”
The socioeconomics of equity funding remain a challenge, as people of color and women startup founders statistically don’t raise as much money as their White male counterparts. The scales are especially tipped today when, as the report says, equity investment is harder to come by for everyone. As an alternative, startups are turning to revenue-based debt financing to fund their growth.
What is revenue-based debt financing?
Revenue-based debt financing is an alternative to equity-based financing—equity in the company in exchange for cash, which is most common—collateral-debt financing, or venture-debt financing. Revenue-based financing is taking out a loan based on future expected revenue that the startup has contracted. This is common in SaaS businesses using a recurring revenue model, but it can be any type of contracted revenue, such as a government RFP.
Companies are being given more time to make a profit—up to six or seven years—to demonstrate their success. Debt rounds of funding made up a tiny proportion of the whole, with more than 230 companies raising $7.85 billion in the first half of 2022. That is still considerably more than the $5.26 billion raised during the same period in 2021.
“As startups adjust to tighter credit conditions by reassessing their financing needs and costs, the advice on what to do with all of the money raised last year may well be to make it last,” according to the analysis.
It’s not all doom and gloom for startups seeking their first or next round of funding. A total of $8.40 billion was raised from 630 pre-seed, seed and series A-C rounds in May 2022. While less than the $13.05 billion raised from 807 rounds in April, according to the S&P analysis, there is still capital available for the sharpest startups.
Check out these tips from top VCs on how to earn those rounds of funding when the time comes.
Get fundamentals right
Eugene Lee, partner at OMERS Ventures, says they’re seeing a consistent picture globally: there is plenty of capital available, but VCs are just adjusting how and when they deploy their dollars. Furthermore, they’re adjusting how quickly they deploy—where closing deals in one day or one week wasn’t unheard of in the recent past, startups should expect longer timelines today.
Lee says that while there is a slight slowdown in certain market sectors, traditional B2B enterprise software companies are still actively raising.
“It seems that the market isn’t being funded on hype, but is back to fundamentals.” Eugene Lee, partner at OMERS Ventures
Ensuring startups are not resting on hype or startup growth hacks will be key going forward, but it’s also solid advice for focusing on what matters: being the best answer to customers’ problems. As Carrot founder Tammy Sun explained on the Sit Down Startup podcast: “Keep your eye on the prospect; the VCs will follow.”
There is also a renewed emphasis on metrics and insights, including net dollar retention (NDR). This has always been an important metric for VCs evaluating their startup investments, but it will likely be even more important now. High NDR, he says, is a sign of a healthier business and stickier customers.
Another silver lining is that those customers are also more likely to renew in a less-certain economic environment, so retaining customers vs. acquiring new ones will be a key muscle to build. While it’s common knowledge that customer retention is much easier than acquiring new customers, this fundamental fact of business can get lost when there is more funding (and maybe distractions).
“At the end of the day, a startup just needs one VC to fund—so while the path may not be as smooth as it was a year ago, there are still funds looking to deploy,” Lee says.
The two Rs: runway and revenue growth
Kyle Duffy, a Sales Partner at Gradient Ventures, works closely with portfolio companies on building and optimizing their sales and customer functions. Duffy finds that startups are more focused on runway and revenue growth, for good reason. Early-stage startups are accelerating their path to revenue and increasing their sales pipeline, which will be essential in demonstrating a solid foundation and a healthy outlook.
“There’s still funding out there for startups with good metrics,” Duffy says. “It’s definitely getting tougher for those without a clear line to revenue.”
Lee observes that companies are opening up earlier rounds or doing extensions of their last rounds to bring in more cash that will help them ride through any downturn. Most companies are focused on cash conservation and balancing that with “growth vs. growth at all costs.” Again—all good habits to maintain, but harder to focus on when startups are more flush with cash.
Focus like you’re already out of money
Focus (and ability to budget) tends to get better when someone only has six months of cash left in the bank. But one tip is achieving that level of focus and sharp decision-making before funds are low.
Sequoia Capital, in its Adapting to Endure presentation shared with founders in the spring to navigate the market conditions, references a phenomenon it calls survival of the quickest: Companies that move the quickest have the most runway and are most likely to avoid the “death spiral.”
“Do the cut exercise—projects R&D, marketing, other expenses. It doesn’t mean you have to pull the trigger, but that you are ready to in the next 30 days if needed. Don’t view cuts as a negative, but as a way to conserve cash and run faster.”
Building and growing on the foundation of customer experience
Customers provide a wealth of information that leaders can—and should—use to measure the health of their businesses. For example, customer support data can suggest where the product could be improved, and net-dollar retention can speak volumes to VCs about how “sticky” a startup’s customer base really is. According to the 2022 Zendesk Customer Experience Trends Report, more than 60 percent of customers will defect to a competitor after one bad experience—a figure that jumps to 76 percent after two bad experiences. Here are some ways to avoid that by taking a customer-focused approach to all of the above.
Lead with products and services
Product-led growth isn’t a new concept for startups, but in the current funding environment this priority has a new emphasis: shifting from that growth-at-all-costs mindset to creating sustained economic value. Startup success means maintaining a strong pulse on customer needs and meeting them where they are: understanding pain points, customer churn, and providing business value that leads to sustainable revenue growth.
Sun advises that founders understand their category–customers and competitors alike–inside and out. Modern Health Founder and CEO Alyson Watson, also speaking on the Sit Down Startup podcast, similarly advises startups “ruthlessly prioritize” the problem they set out to solve. While it may be difficult to filter decisions and initiatives this way, it can build a foundation of discipline that drives growth and ultimately impresses VCs.
Customer retention = Financial freedom
The cost of acquiring a new customer can be up to 25 times more expensive than retaining an existing one. Reducing churn and expanding business with the same customers will is an especially important strategy to hone in leaner times. One approach: DocSend CEO and Founder Russ Heddleston focuses on what he called “high-usage” customers, attempting to understand where and how they were getting the most value from his product. Meeting customers wherever they are and anticipating their needs makes the experience smoother for all involved. Whether customers are browsing on the ecommerce website or searching a help center for assistance, a customer experience designed to meet their needs will be essential for a long-term relationship.
For startups concerned about the funding environment, keeping these tips in mind can help ensure they stay afloat and even thrive in the short- and long-term.