Securing Venture Capital for Your Business in This Economy Means Getting Back to Basics. Here's How. Despite an often alarmist outlook, venture capital funds haven't disappeared; you just have to take a fundamentals-first approach to get them.
By Douglas Wilber Edited by Maria Bailey
Opinions expressed by BIZ Experiences contributors are their own.
It's tough out there for businesses looking to raise money. After several record-breaking years, startups saw funding cut in half in the third quarter of 2022, according to Crunchbase News. Even as many of us wonder if we've hit bottom, there's reason to be hopeful that dollars in reserve could boost prospects in 2023. Whatever the market holds, venture capital funding will likely look different in the coming years, with VCs prioritizing evidence of focused, sustainable growth in the companies they back.
Simply put: In this environment, it's about going back to basics.
If this sounds familiar, it's because tech's gone through similar contractions before. During the dot-com bubble, companies posted outrageous growth rates fueled by eager investors, but what goes up must come down. The ones that survived, such as eBay and Priceline, had strong business fundamentals and measured growth.
Taking a lesson from the past, it's now about creating a scalable business, not raising money to grow at all costs, and it's definitely not about burning through it at a wild pace.
As someone who routinely mentors early-stage fintech startup leaders and teams, I know how scary it can be to read headlines warning about venture capital seemingly slowing to a trickle. Rest assured that capital is available; it's just being deployed differently. Instead, it's being held in reserve as "dry powder," or capital that's been committed by investors to fund innovation but hasn't yet been allocated to a specific investment. In fact, record amounts of capital are waiting on the sidelines, according to EY, which should be cause for optimism.
Securing a deal starts with understanding how the landscape has shifted. Before and even during the pandemic, investors were flush with cash. That deal competition led to higher valuations, but now VCs are being more selective about where funding goes — expecting more value from each dollar they invest. They're looking for capital-efficient businesses with compelling metrics, strong leadership teams and records of managed scalability.
VCs are smart to be selective as they deploy capital. Today's fluctuating stocks and general economic uncertainty are impacting valuations. Several high-flying companies — including Stripe, Instacart and Klarna — have lowered valuations this year. These moves illustrate venture capital's increasing drive for real-life figures, versus a "growth at all costs" mentality. Expect to see similar valuation adjustments across the board, and prepare to give your own company's value a good, hard look before soliciting VC funds.
How to attract increasingly selective venture capitalists
Winning over choosy VCs right now is about going back to business fundamentals. If you're a startup founder eager to solicit funding, you must demonstrate a real-world ability to produce sustainable growth.
But how?
1. Understand your customers
"Who are your customers, and why do they want what you're offering?" You can expect all venture capitalists to ask this question, so it's vital to demonstrate an in-depth understanding of customers, including their pain points, and offer viable and differentiated solutions that help them.
Again, don't overlook the importance of the fundamentals here. Once you know your customers, you must have a clear-cut plan to acquire them in a profitable way and then prove to VCs that there are enough of them to scale a business. This is your total addressable market (or TAM), and the more you understand yours, the simpler it will be to provide customers with solutions. You must also show that you can repeat these cycles and scale.
This brings us to your unique selling proposition. Differentiation is key to beating competitors in business, as well as attracting VCs. As a leader, you must be able to pitch a unique solution that solves a customer problem you've identified within your TAM, then prove that your solution is better than available alternatives. Investors want to see and understand why someone would choose your company over competitors.
Related: 3 Ways to Differentiate Your Business in a Competitive Market
2. Know unit economics
Contrary to popular belief, venture capitalists don't expect your business to be profitable immediately. Remember dry powder? Many VCs use that capital to help startups move from positions of unprofitability to profitability. When Crunchbase examined the earnings of 12 venture-backed companies over the course of a year, including the highest-valued recent market entrants, they found that three-quarters posted losses of approximately $100 million.
So, even if you're operating in the red, you can still win an investment deal. But investors need to see that you're bringing in customers profitably, which requires sophisticated, trackable sales and marketing measures.
Also, be prepared to show and justify all the variable sales and marketing costs that go into driving lead generation and constructing a healthy selling pipeline. As an organization matures and it generates recurring revenue, those sales and marketing expenses will play less of a role. Put simply: Before you're profitable, you have to demonstrate a reasonable path to profitability.
3. Embrace investable metrics
Investors today want to see that startups have road maps to sustainable growth, and the wisest way to show that is through up-to-date metrics. Knowing your customer acquisition cost, CAC payback time, customer lifetime value, annual recurring revenue by employee and gross margins will make you more investable. Besides, having those figures at hand gives you the confidence to make good decisions anyway.
At Denim Social, we've secured two rounds of venture funding by looking at those metrics just mentioned, as well as several others: year-over-year growth, net revenue retention and so on. That way, we give more than lip service to a promise of viability — can support the assertions that our company is a good risk for investors.
Numbers don't lie. You might not like the ones you see if you haven't stayed on top of key performance indicators, but it's better to learn that you need to make changes before you try to attract venture capital funds. You can be sure they'll look at all the angles before agreeing to any investment partnerships.
Related: Can You Scale a Startup Without Venture Investment?
No matter what you've heard, this category of money hasn't dried up. Investors are just being more discerning than they have for the past 24 months. Your role is to help them see why your startup is worth their time, effort and dollars by being practical, and prepared.
