In March, payments processor Stripe made headlines by raising $6.5 billion in a funding round, but the catch was that its valuation had significantly dropped to $50 billion, nearly 50% lower than just two years ago. This steep decline in valuation reflects a broader transformation in the startup funding landscape. Fledgling companies that once thrived on eager investors and abundant capital now find themselves in a world of reduced funding availability, more selective financial backers, and higher funding thresholds.
The era of cheap money, which saw a flood of capital into startups due to ultra-low interest rates following the 2008 financial crisis, has come to an end. By July this year, venture capital firms had invested just $80 billion into startups, primarily driven by a series of high-profile generative AI deals. This pales in comparison to the $246 billion invested in the previous year, which itself was down from the peak of $347 billion in 2021, according to PitchBook.
For growing businesses, this means a greater emphasis on financial metrics such as profitability and cash burn when seeking investment. We spoke to Davide Sola, a professor of entrepreneurship at ESCP’s London campus, on strategies that entrepreneurs can adopt to secure funding in this evolving economic environment, all while becoming more resource-efficient in the face of constraints in funding availability.
Startups will need more than a persuasive PowerPoint presentation to attract investment; they will need to demonstrate the product’s viability and secure paying customers.Prof. Davide Sola
The impact of rising interest rates
Sola notes that worsening economic conditions have dampened the appetite for riskier investments, leaving many startups in dire need of capital and facing steep declines in their valuations.
“It will be much more difficult for startups to raise money as there is less capital available, and it’s looking for much higher-quality businesses,” our expert says. “Anything that is not AI or is not super scientific, like a new drug or quantum computing, may need to wait a few years before funding comes in.”
This marks a huge change from recent history. From the start of 2017 through the end of 2021 – according to the FT – investment volumes increased almost fourfold as venture funds attracted capital from institutional investors aiming to take advantage of soaring valuations, especially in the tech industry. However, the landscape has shifted dramatically, with many startups witnessing a significant drop in private market valuations, prompting venture capitalists to re-evaluate the worth of the companies in their portfolios.
But Sola says it’s actually a good thing for the health of the startup ecosystem and the wider economy. “This is very good news, as it will be much easier for good businesses to differentiate themselves — those who have proof of customers, a decent management team and a path to profitability. The rest are now in trouble. It’s only when the tide goes out that you discover who’s been swimming naked,” he says, quoting legendary investor Warren Buffet.
It will be much more difficult for startups to raise money as there is less capital available, and it’s looking for much higher-quality businesses.
Bootstrapping and a return to self-sufficiency
Sola anticipates a return to bootstrapping, a funding strategy that relies on a company’s own resources, including personal savings and revenue generated by the business, rather than external funding sources like venture capital or loans. “If you want to raise venture capital funding, you’re going to have to have a very strong business case and a good foundation built with your own resources rather than someone else’s money,” he says.
He points to iconic founders like Jeff Bezos, who initially invested $10,000 of his own money to start Amazon, working out of his garage with a small team to build the e-commerce website. “For too long, startups have relied on raising cheap capital and spending on lavish offices with amenities like ping-pong tables and free food for staff. Now, it’s time to focus on building a solid business,” Sola says.
For those who do secure funding, it will often now come at a depressed valuation. “A big investor recently told me that the time when investors based their valuations on a multiple of sales is finished. In the SaaS industry, a few years ago, investors were prepared to pay 20 times the revenue for an equity stake. Now those valuations will go down to a level that compares to the risk,” Sola says.
And the investors will expect a more significant ownership stake, while companies will need to work harder to secure financial backing. “Startups will need more than a persuasive PowerPoint presentation to attract investment; they will need to demonstrate the product’s viability and secure paying customers,” Sola says.
Cash runway and the importance of financial planning
Lastly, our expert says that fledgling entrepreneurs will need to conserve their cash runways and be more cost-conscious. The “cash runway” is a financial metric for the estimated amount of time a startup can operate before it exhausts its available cash resources. It is a critical indicator of a start-up’s financial health, which can help in making decisions about investment and funding.
“You need to look for money well in advance,” says Sola. “If you have a run rate that is six months, you’re already on red alert. Even if your runway is 12-15 months, look for money now to get ahead of the problem.”
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