Here on the eve of Thanksgiving in the United States, this column spent a good portion of the morning hunting up something to be thankful for in startup land.
There are options: The world has never been more software-centric, meaning that the core startup product is well aligned with long-term macroeconomic trends. That’s good. Consumers are also holding up better than some expected given the global backdrop of rising interest rates and hard-to-tame inflation. Despite endless calls for a recession either tomorrow or the day after, key economies in tech continue to grow.
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Sadly, for many startups, the news is overall more negative than positive. For example, tech investment is falling, valuations are down, IPOs are frozen, layoffs abound, and startups that decided to put off fundraising due to turbulent market conditions may wind up with the short end of the valuation stick. (The good-news version of this point is that some startups did raise during the earlier quarters of the present tech-market downturn, which wound up being the right move!)
Data from Forge’s November 2022 report — the company operates a secondary market for the trading of private-market tech shares — indicates that startups that raised earlier in the present downturn wound up collecting fewer down rounds and received better overall pricing than their more reticent brethren.
This should not surprise; as a downturn deepens, it makes sense that investor confidence would ebb along with the market itself. But the numbers are worth chewing on all the same as they provide a fascinating lens into how fast things changed and offer a little advice to startups when it comes to taking lumps in the fundraising market.
Let’s look at the numbers.
Sooner, later
Much like TechCrunch, Forge marks the beginning of the present startup downturn in late 2021. While our pages were making a good amount of noise in early December of last year on the matter, Forge marks November as its starting line. In hindsight, we agree.
We have two periods to consider: The first from November 2021 through April 2022 and the second from May through October of this year. Per Forge, here’s how startups that raised primary capital in the two periods stacked up:
- Percent raising a down round: 2.3% (earlier period) versus 8.5% (later period).
- Average valuation gain from new round: 4.19x versus 3.08x.
- Median valuation gain from new round: 2.52x versus 1.78x.
Whenever we consider numbers to compare, we have to ask if their difference is notable. A change in 1 million units, to make up an example, might sound like a huge shift in a particular metric, but if we’re comparing two numbers in the trillions, it’s a rounding error.
A 6.2-point difference in the percentage of startups raising a down round when you compare the two periods might not seem like much, but that’s a 270% increase. That’s no rounding error; that’s incredibly material.
Similarly, when we consider the change in median valuation gains from new rounds in both time periods, the decline is not a small figure, but a sharp 29% decrease.
To avoid a down round then, and to defend valuation upside, startups would have been better off stacking capital immediately instead of waiting in hope that valuations recover. (Note our reporting yesterday on the valuation recovery question for more on that point.) This tells us that no matter the health of a startup — if they want to conserve upside and prevent downside, fundraising quickly when a downturn hits is the way to approach the venture market.
Mostly. There are a host of unicorns waiting for sunnier climes to return to the venture market. You might think that, given the above, they are making a mistake. But as we learned this week, a good number may have over a year of cash left. Furthermore, some venture investors do expect at least a modest valuation rebound from the present day. There is a chance that such companies will be able to thread the needle, hold off for better market conditions and grow into their prior valuation over the same time interval. But how many unicorns waiting today to raise new capital will manage the feat? What fraction won’t be able to raise later, period?
That wager is one we’ll track in 2023. But for every startup that isn’t an overfed unicorn, well, the math is simple: When the markets wobble, gobble up all the cash you can, as soon as you can. Else you might be left with less capital and more bag later on.