The Summer of Our Disintegration: How To Keep Your Head While Everyone Else Is Losing Theirs
We all know of the winter of our discontent. This will be worse. Think of it as the summer of our disintegration.
The full sense of that word is “the coming apart of things once cohesive,” and that pretty much captures the core of the impending chaotic season.
What is disintegrating? So many external factors: Supply chains. Peace in Europe. Weather patterns. Traditional monetary controls. Stock markets. Crypto valuations. Must I go on?
And venture fundamentals too have largely turned south. SoftBank is pulling back by 50–75% on startup investments after announcing huge losses. Likewise, Tiger Global lost $17 billion and has almost fully invested its latest fund. Average U.S. VC later stage pre-valuations dropped from $731.6 million in 2021 to $572 million in the first quarter of 2022. SPACs, once the new darling of exits, have collapsed. The valuation of crypto bellwether Coinbase has fallen nearly 80% since its direct listing last year.
Enough red flags for you?
So, what does this mean for venture funds, and much more importantly for startups?
For funds, this summer is a reaping of years of excess. Too many funds, too many deals, outrageous valuations, bubble behaviors, the gamut of riotous foolishness. Now comes the deep, dark hangover. Funds need to get back to, well, fundamentals. What is the true value of a new technology or scientific capability in terms of the real benefit it can bring people and the revenue it can produce in a 5-year timeframe? Can it achieve profitability? Does the team actually have a plan to win and is that plan doable in the few years a venture fund has to deliver an exit? And how will exits happen, with public markets fibrillating and big companies frozen by the shock of recent events?
In short, funds have to pull back on pace and valuation, put in the hard work to rationally value companies, and show the discipline of only investing when they feel they can see the full arc of development of a company.
If funds are pulling back — and they are, across all geographies and sectors — then entrepreneurs have to be prepared for one of the worst fundraising seasons in recent memory. In a note to its founders, YCombinator said this week:
“If your plan is to raise money in the next 6–12 months, you might be raising at the peak of the downturn. Remember that your chances of success are extremely low even if your company is doing well. We recommend you change your plan.”
Public market multiples are down, so venture company multiples will most likely slide down with them.
The degree of change is emphasized by a “Framework for Navigating Down Markets” created by Andreesen Horowitz a few days ago. They recommend:
“A helpful exercise is to figure out what ARR you need to reach to get back to your last round’s valuation and plan accordingly. To do this, use the estimated change in valuation multiples from leading public companies in your space and add a growth- and efficiency-adjusted premium for your faster growth. Then use this number to calculate the ARR you need to get to. Your goal should be to hit this revenue target with at least 12 months of runway. If you can do this, you’ll be in a strong position to raise your next round of funding. Raising capital with less than 12 months of runway sends a negative signal to the market and makes it harder to have a good fundraise.”
Here are our simple, sober rules for how you can keep your head while all around you are losing theirs:
If you can avoid raising this year, do it. Don’t raise this year unless you absolutely have to. Valuations will be weak. Terms will be tough. Investors will be skittish. Negotiations will take forever. With all the perturbation in the world, this will simply not be a great environment to raise in.
Accept the current market. Rage won’t help. If you absolutely have to raise, understand that if you stand out in the rain, you’ll get wet. Think small in terms of your raise, think about Notes/Safes, so the ultimate question of valuation gets pushed into the future. Think about grants and other forms of non-dilutive cash flow to get you through. Understand that investors are clever: they know you might not accept a super-low price, but they will support even a moderate valuation with heavily investor-friendly terms. We have seen double board seats and participating preferred downside protections in recent deals. You can expect this in deals you do this year. Longtime VC Bill Gurley calls this “the Dirty Term Sheet” and counsels entrepreneurs to avoid it at all costs.
Control what you can control. You can’t control the public markets or investor behavior. You can’t control your customers. But you can control what you spend. So do that. This is a period to favor endurance over growth. Don’t speculate now. Hunker down. Buy yourself the time to get through the current turbulence.
Talk to your current investors and customers (and listen!). I said talk, not pitch. Don’t hit them up for money. Talk with them about the current market, the state of the business, the state of their funds. Ask for their advice. And listen to all they say. Good ideas or shared plans may emerge. At worst, you’ll wind up with a stronger sense of one another.
Hard times like these are when funds and founders find out what they are made of. Be one of the survivors!
By Managing Partner Mike Edelhart