After years of exuberance, venture capitalists are becoming more selective about where they invest. And many startups have found that raising capital is more difficult.
By Leah Hodgson, PitchBook
Investors pay more attention to the pitch financials and take longer with their investment decisions. At the same time, many of the same rules apply—with a focus on a startup's long-term prospects and the quality of the founding team.
“[The first meeting] is extremely important,” said Techstars CEO Maëlle Gavet. “You should think about it a little bit like a date. You have to make a good first impression. Will it be enough to get married? No. But if you make a really bad first impression, it's gonna be hard to get back on track.”
The numbers paint a grim picture for those raising their first round. VC deal count is down nearly 33% globally at midyear 2023, compared with the same period last year, according to PitchBook data. Meanwhile, the PitchBook VC Dealmaking Indicator released July 3 shows how the dealmaking environment has tipped in favor of investors since the start of 2022 amid growing demand for capital from startups.
With valuations under pressure and investor caution in the market, founders need to sell a compelling story to their prospective backers.
There is hope. VCs are still sitting on record amounts of dry powder and rounds are still being closed, albeit at a slower pace. So how do you, as a founder, raise capital in a downturn?
It all starts with the pitch.
Focus on financials
Because of investors' heightened sense of caution, financial fundamentals have become a much bigger focus in the past 18 months, said Shmuel Chafets, general partner at Target Global.
“You need to focus on the fundamentals,” Chafets said. “Back in 2021, investors were very focused on growth metrics, and of course, today that's shifted to profitability. You need to adjust your business to what the market is now and think about unit economics and burn and all the things that didn't matter two or three years ago but do today.”
Growth is still important. But for companies in the later stages, demonstrating a path to profitability is attractive to investors. Founders should be able to show VCs that they have thought about how best to allocate resources and be efficient with the capital they’re planning to raise.
Chafets added that founders must also be careful with their expectations both in terms of how much they’re raising and their target valuation. Price tags seen in 2021 are unlikely to be achievable for most startups in the current environment, so many founders will have to lower their ambitions.
It is also likely that founders are going to have to accept less-favorable terms in exchange for capital, Gavet said. Increasingly, VCs are looking for more protection and are introducing more investor-friendly terms when negotiating.
Know your business
Even during the VC funding peak, founders had to prove that startups' offerings were defensible. However, this need is now magnified at a time when there are more competitors chasing after a smaller pool of capital.
When it comes to the product or technology itself, investors are looking closely at which problems a startup is trying to solve.
Gavet emphasizes the importance of being specific in what opportunity your product or service is taking advantage of in the current climate.
This requires in-depth knowledge of the market in terms of how big it is and who your startup's rivals are. According to Chafets, startups need to be able to articulate their long-term visions for the company—as well as the short-term milestones that need to be reached to achieve that vision.
At the same time, it’s essential that founders can outline their limitations, said General Catalyst partner Juliet Bailin.
“It’s far better for a founder to point out a potential yellow flag or unresolved problem about their business than for me to mention it first,” she said. “I’m less concerned about problems that founders bring up because I know that it’s at the top of their minds.”
Founders first
While financials are becoming more prominent, Bailin said that the quality of the founders are the main draw, even in a harsher fundraising market. This is particularly true for startups at the earlier stages, where numbers are hard to come by and the product may not even be built yet.
“For us at the early stage, it’s founder first,” Bailin said. “A founder’s expertise is directly related to their ability to build the most unique product. A startup can have the best ideas, but if the founder isn’t equipped to build and distribute them, then they’re going to be beaten.”
For a successful pitch, according to Bailin, a founder should emphasize how their expertise and experiences make them the best person to build and grow the product.
As always, there is no one-size-fits-all approach when it comes to pitching for startups, Gavet said, as investors have different priorities. Pitches must be targeted. Making sure that a pitch is targeted to the right kind of VC—one that will align with the founders' goals—is a good first step when raising capital. Founders can tailor their presentations to fit an investor’s focus: for example, emphasizing numbers vs. the team depending on whether the VC is more data-driven or personality-driven.
An introduction to a VC by someone in the founder’s network or informal meetings with investors to establish relationships before fundraising are both useful ways for entrepreneurs to get a foot in the door.