It is difficult for startup companies to
raise venture capital at the best of times.
A venture capitalist might
get emailed 5-10 pitches from startups each day. Over the course of a
year that adds up to 2,500-5,000 pitches. Of those pitches, that
venture capitalist might fund one or two companies. Not great odds for
a startup. Granted, some of the other startups may raise funding from
other venture capital firms, but even so, it’s a chancy proposition.
Recently, startups have been facing an even more difficult
environment for raising capital. There are three factors that are
contributing to this. Some of these factors will change in the short
term, but others will likely continue to be a factor for a while. From
longest to shortest then:
Angel financing has dried up. Often, when a company
is too early to raise institutional venture capital it will raise money
from angel investors – wealthy individuals.
According to the Center for Venture Research,
$26B was invested by angels in 2007, a marked increase compared to
$15.7B in 2002. The precipitous drop in stock markets and housing
markets since the beginning of the year has made many angel investors
nervous about making new investments in risky and illiquid startups.
Many angel investors will likely sit on the sidelines until we see a
rise in stock markets and in consumer confidence. While the companies
who raise angel financing would not likely have raised from venture
capital firms anyway, a slowing down of angel financing will mean that
less companies are ready for institutional venture capital in the next
few years.
A slowing economy has reduced near term revenue growth expectations.
We are in a recession. While for many startups, the micro factors (e.g.
Did we hire our second sales person in Q1 or Q3? Was our VC able to
introduce us to BigCo for a distribution deal?) trump the macro
factors, startups still operate in the same economy as everyone else.
With consumers and enterprises alike watching their spending closely,
even the most promising startups are likely to see slower growth than
they might have projected a year ago. Slower revenue growth usually
translates into a longer period before the company gets to
profitability, and hence more capital required. Strong companies will
still get funded, but each financing may be a little larger than in the
recent past to give the companies the additional runway to get to
profitability. As a result, there may be a slight reduction in the
overall number of financings (given that the pool of available capital
is largely the same) and some marginal companies will not be able to
raise capital. Since early stage venture capital firms by definition
take a long term view, this impact is likely small, but will persist
until investor expectations for consumer and enterprise spending
improve. As we get additional data on the likely length and depth of
this recession through 2009, this effect will likely disappear.
Venture Capitalists are focusing on their portfolio companies.
The slowing economy affects not just companies raising finance, but
also companies that have already been funded. VCs are currently fully
engaged with their current portfolio, helping them to prepare for a
tough 2009. Many entrepreneurs are first time CEOs, and some were not
even in the workforce during the last recession. They are turning to
their VC investors to help them think through what actions their
companies need to take to adjust; cost reductions, changes in strategic
direction, or otherwise. This takes time. Time spent by VCs with
portfolio companies is time not spent looking at new potential
investments. As a result, companies currently seeking financing may not
get the same level of attention that they might have received a few
months ago. The good news for startups is that this is a short term
effect. 2009 planning should be completed within the next few weeks,
and certainly after the holidays, venture capitalists time will once
again free up to look at new deals.
Better time ahead. Although startups seeking
financing right now may have a tough time, as these factors fade away
they should see a relative improvement in the very short term. As the
market will only improve, startups looking to raise new financing
should try to defer for as long as possible. This may require cutting
costs to extend the cash runway, reducing the scope of projects,
prioritizing revenue over new features or looking to existing investors
to provide a bridge loan. But do not lose hope! Promising companies
will continue to get funded, with the pace returning to close to normal
by part way through 2009.
(Note: For more from Jeremy Liew, visit his blog)
