In the past few months, global equity markets have been in a slump. In such a macroeconomic environment, investors are more cautious about pouring money into risky ventures, as VCs are also becoming much more risk-averse. Additionally, as inflation is on the rise, investors are becoming uncertain about the potential profits they would get in return. Thus, fundraising in a downturn is not an easy task.
While at one point the Southeast Europe region was booming with the rise of the soonicorn companies and many were anticipating an unprecedented growth, the past six months of 2022 have had a reverse trend, with many valuations suffering a sudden drop.
In a high interest-rate environment, the cost of capital is higher and this has an impact on the valuation of companies. Therefore, many startups are now raising funds at a lower valuation than they would have in the past.
The Recursive talked to several VCs and angel investors from the region about their thoughts on the current investment climate and what fundraising in a downturn entails.
Here is a selection of the key insights shared below:
• “Valuations in Europe are not as crazy as before, and with the crash of the crypto markets, inflation and the war, there is a pressure for lower valuations.”
• “We have however seen funding offers falling from ~200x multiples to ~30x in the SaaS space and that has led to some founders delaying new fundraises.”
• “Market multiples have been dropping at least 8-20% over the last 6 months and projections for the end of the year are not giving a more optimistic view.”
• “The startups that show value for their investors and are keeping up with their track record and growth rates are the ones that may take advantage of the developing situation.”
• “If you have reasonable expectations about valuations and you have a good story and traction, you can still fundraise successfully even in hard times.”
The Recursive: How does the current macroeconomics affect the valuation of the so-called soonicorns?
Igor Madzov, North Macedonia-based angel investor: After the mid of 2020 and the COVID-19 breakout, we saw a decrease in the number of rounds but a huge bump in valuations worldwide. Yet in the last 2 years, a significant number of companies in CEE started to become unicorns for the first time and an expansion of the soonicorn club, so we don’t expect that trend to stop.
Valuations in Europe are not as crazy as before, and with the crash of the crypto markets, inflation and the war, there is a pressure for lower valuations. Costs are higher so there will be rounds with similar valuations and ticket size, but I’m expecting longer runways.
Nikola Yanev, Eleven Ventures: If soonicorns were aiming to become full fledged unicorns this year, they would likely have to wait a bit longer for the coveted billion mark. However, the fact that they were already rising stars, likely means that most of them have their coffers full of cash, so they can safely weather the storm.
Raya Yunakova, LAUNCHub Ventures: The environment at the later stages has been challenging for the past few months and we expect it to remain so in the short-term. The main implication of this are delayed funding rounds and the resulting constriction in growth that companies can realize. This makes it difficult to have an actual assessment of the valuations as the good companies are simply waiting for a more favorable environment before they close a round. We have however seen funding offers falling from ~200x multiples to ~30x in the SaaS space and that has led to some founders delaying new fundraises when they are in a position to turn to profitable unit economics and wait out the storm. With the ones that aren’t doing so well we might start seeing some early acquisitions.
Dora Trachana, Uni.Fund: During the last decade, we saw an increasing inrush of VC capital, which has positively affected the growth of the tech startup scene, but may have also created a bubble. Stats show that 2021 has been a record-year in terms of startup valuations, while the first 6 months of 2022 have brought up a bit of investors’ hesitation, which definitely drives valuations down.
The global macroeconomic crisis that we’re all afraid of is around the corner, and has created some turbulence, which seems to be moving the startup market towards more rationality. Market multiples have been dropping at least 8-20% over the last 6 months and projections for the end of the year are not giving a more optimistic view.
Within this unknown environment, soonicorns may not be able to achieve all their ambitious goals and may need to reshape their strategies, not only the fundraising ones, but also the sales-related in order to achieve lower burn rates, longer runway and ensure alternative ways of fueling their growth. Companies are not born to become unicorns; they are born to become real businesses; and real businesses focus on generating revenue and profits rather than increasing valuations.
The Recursive: How do you see the future of startup funding developing in these circumstances?
Igor Madzov: VC funds are definitely on the lookout for the best deals, but are tempted to do fewer rounds and encourage their portfolio to become leaner and extend their runway. It is going to be super hard to close small seed and bridge tickets and we foresee that the most active VCs will be pickier. The beauty is that in crises only the bold make it out on the top, so VC companies that make the leap to support driven founders and make it fast will benefit the most.
Nikola Yanev, Eleven Ventures: Currently, funding rounds take longer to close, unless startups are willing to consider smaller round sizes at valuations closer to their latest round. Although similar downturns usually take 12 months to pass, the perception changes and lingers on for a while, so the market usually settles at lower levels than before the crisis. So, in essence, this means that the scales would be tipped a bit more in favor of investors in the coming one-two years.
Raya Yunakova, LAUNCHub Ventures: We expect the funding environment at the later stages to remain slower until we start seeing the first signs of public markets recovery. At the earlier stage, where LAUNCHub Ventures invests, we are not seeing a massive correction as of now. In Europe, we’re having a low double digit decline year on year at the seed and Series A stages (Q2’22 compared to Q2’23) and flat quarter on quarter numbers (Q2’22 compared to Q1’22).
Having in mind the new capital committed to seed funds during the past couple of years, we don’t expect drastic reductions in funding availability at seed on the whole. That being said, individual funds who are approaching the end of their deployment phase have started reducing the pace of new investments. Nonetheless, we still see it as a seller’s market at the seed phase in CEE although slightly more balanced compared to the market peak.
Dora Trachana, Uni.Fund: As with the first months of the COVID-19 crisis, fundraising has become difficult during the last 3-6 months. Private capital has been kept away from new investments with both startups and funds affected.
However, as always, the ones that show value for their investors and are keeping up with their track record and growth rates are the ones that may take advantage of the developing situation. Investors are still searching for returns and nothing is better than a combination of the startup environment’s returns combined with the traditional businesses’ security.
The Recursive: What can startups and companies do to increase their chances of fundraising in a downturn?
Igor Madzov: Deal closing will take longer than usual, so seed funded startups need to start fundraising as soon as they reach 12 months of runway. It will be easier to fundraise for all those companies that solve real problems for their customers (painkiller product) and have very loyal customer base relations. If so, this is another opportunity to push on expansion, ask for referral and focus more on authentic content marketing.
Nikola Yanev, Eleven Ventures: The market for good companies didn’t disappear and won’t disappear. Fundraising in a downturn just takes a little bit more time, and you have to factor that into your strategy. There is still a lot of capital out there and that capital will bet on the future market leaders. If you have reasonable expectations about valuations and you have a good story and traction, you can still fundraise successfully even in hard times.
This leads us to another point – don’t start high with your valuation expectations. If you can get the money, get the money – don’t haggle about valuations, don’t go into endless debates on terms, don’t be as picky as you would normally be in a different market. Because just surviving a crisis is winning and anything that helps you win or prepare to win is good.
If you are raising money, be smart about designing your fundraising strategy. It is important to understand and analyze how your business is growing. If you understand your growth better, it could turn out that in 10 months, you are in a much different shape than today.
When structuring your fundraising strategy and needs, don’t do it entirely based on what is the state of the business today, but take into account what will be the state of the business in 12 months. Because if everything goes well, you might need half of the money to achieve certain milestones and so optimize dilution, valuation, and everything else.
Raya Yunakova, LAUNCHub Ventures: Positive unit economics are always sexy and now having a clear path to achieving them is even more attractive to investors. I would advise companies to be more strict in acquiring new customers in a cost efficient yet scalable manner (easy to say, I know) and pay extra attention to things like customer acquisition cost, average contract value, and net dollar retention.
Achieving contract value expansion, while keeping churn low is going to aid massively not just in fundraising in a downturn, but in growing the business overall.This is a great time to become more efficient in the way you do business.
Dora Trachana, Uni.Fund: When funding gets into scarcity, the best thing to do is to secure profitability or, at least, cash flow positivity. During the last 5 years in Uni.Fund, our motto has been ‘cash flow positive’ and we have been always pushing our portfolio companies to examine alternatives that decrease their burn rates and extend their runways.
Additionally, startups should be vigilant on any funding opportunities that may extend their runway, either these come from potential investors, grants or loans. The fundraising game has a fact: you don’t get the money when you need, you get the money when you can.