Startup Funding Shift in 2023: Understanding and Navigating the Brave New World of Venture Capital

Table of Contents

1. The Changing Funding Environment

2. Making Sense of the Shift: A Look at the Data

3. Funding Volumes: A Return to Baseline

4. Adapting to the New Norm

5. Realistic Valuations

6. Conclusion

The Changing Funding Environment

The startup ecosystem is in a constant state of flux, influenced by various macroeconomic factors. After two fruitful years in 2021 and 2022, we are now witnessing changes in the funding landscape. Interest rates have risen, and inflation remains at high levels, impacting startups, some of which have faced shutdowns at above-average rates. Recent notable incidents involving Silicon Valley Bank, FTX, BlockFi, and Celsius have further added to the challenges faced by startups in an evolving funding environment.

Making Sense of the Shift: A Look at the Data

To gain a deeper understanding of the venture capital dynamics for startups, let's turn our attention to data from Crunchbase and the Financial Times. In the video above, you will see a graph that offers insights into the current funding landscape. Notably, investment activity in 2023 has experienced a significant decline, especially in the late-stage and private equity sectors, which means Series B and C startups are particularly affected. However, early-stage and angel investments have remained relatively robust, indicating resilience in the funding ecosystem for early-stage startups.

Funding Volumes: A Return to Baseline

One crucial message emerges from the data: when we extend our time horizon beyond 2022 and 2021, we observe that 2023 funding volumes are returning to levels similar to those seen in 2020 and earlier. This finding reminds us not to anchor ourselves solely against the recent past, but to extend our time horizon and consider the broader historical context. It's important to note that 2020 and years prior were great years for startups, suggesting that we are returning to a healthy baseline for funding. While the immediate decrease in investment activity may seem concerning, this shift towards a sustainable environment, free from the exuberance of the pandemic years, is a positive and healthy trend.

Adapting to the New Norm

As startup founders and leaders, it is crucial to adapt to the evolving funding landscape. Rejecting data and sticking to outdated beliefs can be a lethal mistake. It is our responsibility to embrace agility, a term often associated with enterprises but inherent to startups. Here are some practical tips for navigating the current environment:

1. Accepting Change: Recognize that the current funding climate is likely to persist for the next 1-2 years. Adaptability and resilience are key to success. While there is a possibility of adjustments in interest rate policies if inflation decreases, it is important to operate under the assumption that the current conditions will prevail.

2. Monitor Public Data: Stay informed about inflation, interest rates, and public market activity. If the IPO market is inactive, investors may be more inclined to hold onto their cash, as their returns come from selling equity to incoming investors at higher prices.

3. Fundraising Timeline: Plan for a longer fundraising timeline, allowing up to six months to secure funding. Adequate runway planning is crucial to avoid being in a vulnerable position during negotiations. Avoid banking on miracles, such as raising capital in 2-4 weeks. This approach is unwise in any funding environment, but particularly risky in the current climate.

4. Avoid Gaming the System: Instead of attempting to time the market, focus on strategic planning and execution within the constraints of the current funding environment. While it may make sense to burn just that bit more of runway to hit near-term value inflection points, holding out solely for a higher valuation is not advisable unless absolutely necessary.

5. Explore Venture Capital Alternatives: While institutional capital is a dream-come-true for many startups, it’s just a means to an end. Capital can be found elsewhere, most notably in cash flow coming from your customers. You may also be eligible for revenue-based financing from players like Pipe and Capchase, crowdfunding opportunities like Kickstarter, and non-dilutive funding from grants and select accelerators or incubators. Personally, I have a massive preference for funding my businesses off of cash flow from customers, even if it means offering consulting services around your product (but don’t let investors know that you have done consulting).

Realistic Valuations

The funding boom of 2021 and 2022 led to inflated valuations, primarily driven by high revenue multiples. However, the declining price-to-earnings (P/E) ratios for technology companies in public markets, which we encourage you to track as mentioned earlier, have rendered these valuations unsustainable. While there is limited data available on current revenue multiples for startups, market observations suggest they range between 10-20x right now.

Interestingly, the most recent report on the State of U.S. Early-Stage Venture by AngelList and SVB, which may not be replicated following SVB's collapse, highlights that early-stage valuations have remained high at the end of 2022 despite revenue multiples (and P/E ratios) not supporting such levels. While this may present an opportunity for founders to set their desired valuations before reliable revenue data becomes available, caution must be exercised.

Setting valuations too high can lead to challenging situations if revenue growth falls short of expectations, which is the case for the majority of startups. The harsh realities of gravity will catch up with you, causing significant challenges in the long run. It is crucial for founders to strike a balance between ambition and feasibility, ensuring that you can grow into your valuation.

Conclusion

While the 2023 funding environment presents its challenges, it also signifies a return to a healthier baseline for startup funding. By acknowledging the changing landscape, adjusting strategies, and focusing on sustainable growth, startups can thrive even in this evolving ecosystem. Remember, getting funded doesn't guarantee success; what actually matters is building great businesses that deliver real value to customers and shareholders.

Rafael and the Zendog Labs team extend their best wishes to all startups navigating the 2023 funding landscape. We understand the journey you're embarking on and are here to support you in supercharging your growth. Whether it's finding product-market fit, accelerating revenue, or securing capital, we're dedicated to empowering startups on their path to success. Keep pushing forward, stay resilient, and never lose sight of your vision. Together, let's create remarkable ventures that make a lasting impact.