February VC funding hits new low
Global monthly funding fell to $18B in February 2023. Not since February 2020 has global funding dipped below $20B in a single month, according to Crunchbase. Funding for the past month was down 63% from $48.8B a year earlier. And month-over-month funding was down 43%. This is a dramatic change that is even more severe for some: Late-stage (Series C and beyond, above $15M) funding fell by 73%, while early-stage (Series A and B, between $3M and $15M) funding was down 52% year-over-year. Angel & Seed stage remained the most resilient, down 38% YoY. For startups that raised their last round in 2021 at peak valuation, the time of reckoning is coming. With typical venture rounds providing 18-24 months of runway, many companies will be coming to market again for more cash in 2H23. For late-stage companies in particular, the notion that the next round will follow the pattern of valuation uplift is now a hope rather than an expectation. Things are expected to get worse through 2023, before they get better. As a result we are seeing a big uptick in extension rounds.
The objective of an extension round is to buy a startup another four to six quarters to grow commercial momentum before trying to raise funds again. These generally fall into one of the following categories, according to Guru Chahal, a VC at Lightspeed Venture Partners: 1. Those valued at an increase from the prior funding, but not a fully fledged round. The valuation is up and the startup has bought another year for execution. 2. A straight extension round is where the funding is kept open and the startup gets more investment at the same valuation. In some instances the investors are given penny warrants, an incentive that converts in the next round to provide more upside to the newer investors. 3. And then there are down rounds. These are now happening with greater regularity, especially where new investors are required to lead. To avoid the pain of repricing now, founders are looking to existing investors where possible to provide bridge financing, often via a convertible note. This extra time gives founders the potential to grow back into a previously elevated valuation and hopefully avoid a down round.
Somewhat confusingly, this slowdown in funding takes place at the same time that dry powder levels are still highly elevated. But unlike 2021, when some new funds were deploying capital over a 1 to 2-year period, we have now reverted to the norm of 3 to 4 years. For VCs that need to raise new funds this is going to take them longer and those fund sizes may well be smaller as LPs step back. The bottom line is that 2023 is going to look a lot more like 2019 than 2022. For founders, that means reduced round sizes and valuations (compared to 2021) with an expectation that capital raised will need to stretch over a 18-24 month period, with the campaign beginning around the 18 month mark. 'Exceptional' Investment propositions will always get funded. These are characterised by 'category-creating' teams, strong customer endorsement, highly credible go to market strategies with clear traction, and financials firmly grounded in solid unit economics more than just growth. 'Good' propositions will endure flat or down rounds, and 'OK' startups will struggle to survive.
Silicon Valley Bank - the impact starts to unfold
The venture industry breathed a huge sigh on Monday: An existential crisis had been averted following the collapse of Silicon Valley Bank last Friday. The US Federal Deposit Insurance Corp., the Treasury Department, and the Federal Reserve moved swiftly to jointly guarantee all deposits of SVB in the US by Sunday night. In the UK, HSBC bought Silicon Valley Bank UK for £1 in a rescue deal announced on Monday by the UK Treasury, confirming customer deposits were protected. HSBC will take on the accounts of SVB UK’s 3,500 customers with deposits worth more than £6.7B. News that an old-fashioned bank run had put SVB in peril began emerging from the US last Thursday. SVB's clients reportedly tried to withdraw nearly $42B in one day from the bank, which drove it to insolvency. Many VCs began extending emergency loans to their portfolio startups to cover immediate operating costs, not least payroll. But many VCs were also using SVB for their own deposits and loans. Some founders began considering liquidating their stakes in the secondary market, where buyers were asking for a 50% discount. In the end these drastic measure weren't required.
As the immediate shock wave subsides, many are now trying to assess the longer-term impact. An excellent primer on what triggered this collapse can be found here, from Marc Rubinstein. But we are only at the beginning of this story. SVB wasn’t just a bank for VC-backed startups — it was “the” bank for such companies. As Pitchbook has reported, SVB was not only the bank of nearly 50% of the tech and life sciences startup market in the US, it was also a lender to many VC-backed companies, as well as the short-term financing provider to VC and PE funds through capital call lines of credit, among other products. In the last three years alone, 240 US VCs raised $86.8 billion across 417 funds, leading Pitchbook to believe a sizeable portion of capital could have been held as deposits with SVB. Still to be determined is how the collapse will impact SVB’s investment arm, SVB Capital, which has roughly $9.5B in assets under management, spread through investments and VC fund commitments. It’s unlikely SVB’s acquirer in the US will be obligated to meet its commitments to VCs as well as provide capital to portfolio companies, which would put further pressure on the market.
As we note above, deal value in the global venture market has declined by around two-thirds over the past four quarters. The SVB collapse could not have come at a worse time and this event will only increase cautionary activity by funds. As VC funding has slowed, venture debt has grown in popularity. The abrupt fall of SVB significantly impacts VC-backed startups that currently hold a loan contract with the bank, especially when it is unclear when the US bank will be sold and whether existing loan terms and conditions will be honoured when an acquirer steps in. For years SVB provided term loans with low interest rates and much structural flexibility, effectively secured by a startup's current VC investors. With SVB's collapse, early-stage startups in the US without a steady revenue stream are likely to encounter severe headwinds seeking alternative means of debt financing. In the UK, despite major outflows in the past week, HSBC is bullish on the opportunity the acquisition presents, as normal operations resume. And for now, this ultra-quick move by HSBC provides much greater certainty for UK customers than it does their US counterparts. Strange old world.
The secret to communicating conviction
Founders are motivated to raise capital so their startups don't run out of cash. But we know that this is not why early stage investors invest. They invest because they buy into you and the incredible opportunity you present. They call this 'building conviction'. Successful founders are able to 'transmit' their own inner conviction to investors. We are conditioned to think that the vehicle for conveying this is the investor deck. But this is only partly true. It is the founder themselves that is the real vehicle. No matter how great your deck is, if you don't radiate conviction that you believe the business will be a success, you won't convince investors. Serial founders that have been down this road before know a secret about communicating conviction. They contextualise their vision, the opportunity and their business strategy, in terms of the market, right from the outset. This is because investors, especially VCs, think in terms of markets. It's in their DNA.
Markets have scale and value, and they define how the various players interact. They contain customers and competitors, and, above all, they can be won (or lost). This is the battleground that institutional investors can most immediately relate to. Even if they don't understand the details of your technology or how the product works, they will certainly want to understand how the company is positioned in the market. It's very rare that a startup creates a completely new market. More likely it will create a new category within an existing market. Even if the startup doesn't have any direct competitors in this newly-defined category, there are nearly always other alternatives. The biggest of these is often inertia. i.e., stick with what you have. The status quo is thus as much a competitor as any other. Understanding both the direct and indirect competitive landscape is vital. This means having a thorough understanding of competitors - including their funding status if they are a new player. Any decent investor will investigate this topic during due diligence, so smart founders make it easy for them.
Experienced investors are very good at pattern recognition - they have seen it all before, many times. One pattern is the technical founder that has developed a product or solution 'obsession'. They may struggle to radiate conviction as they may not naturally think in terms of markets. They may lack this more holistic view and even though they believe they have developed a killer product, growth remains elusive. Conversely, technical founders that operate with a 'market-first' mentality can be highly investible. Think Steve Jobs. They combine an ability to build with the perspective of a user and a clear view of why that user will select them over other alternatives. And lots of users with the same 'problem' equals a market. You may not be the world's smoothest presenter but if you can deftly unpack your unique market positioning, you will be off to a flying start. And it's not just investors that will pay attention. Every other stakeholder from employees to suppliers will buy into the incredible opportunity you are creating.
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