Fund-Raising for Startups Just Became Tougher. Time For Entrepreneurs to Shift Gear!
The Federal Reserve raised interest rates nine times over the last 12 months. This is in response to stubbornly high inflation which is currently at 6% in the US. The European Central Bank in March followed a similar approach, and increased interest rate by half a percentage point to fight inflation which averaged 8,5% across the EU countries. These rates increase confirms that both the US and EU are determined to bring down inflation regardless of the recent Silicon Valley Bank (SVB), Signature Bank and Credit Suisse collapse. In other words, the regulators are trying to reassure the markets that the global banking system is healthy.
Those higher rates make it more expensive to get a mortgage, carry a balance on a credit card as well as raise capital if you are an entrepreneur. Higher rates might have also caused the collapse of SVB which was over exposed to bonds which drastically fell in value because of the Fed’s rate hikes.
Regardless of the Fed and ECB reassurances, fundraising for entrepreneurs just got a lot tougher. Just a bit of background here. Venture deals decreased dramatically in 2022, and over the last quarter of last year, VC poured $10.7 in early-stage companies, less than half of the amount raised in the first quarter of 2022, according to PitchBook. Overall, U.S. Venture Capital deals value decreased by 31% in 2022, to $238 billion. According to the same source, companies exit value reached $71 billion in 2022, representing a gigantic drop from 2021’s record $753 billion in exits. This market “nose-diving” reflects the overall fragile macroeconomic landscape and investors’ reduced appetite for risky ventures. Just to be clear, access to capital has gotten tougher for everyone. If you are seeking a loan from your bank for instance, your lender will pay much greater attention to your creditworthiness, whether you are a small business looking for a loan to finance growth or pay down debt, or if you are a home buyer trying to secure a house mortgage.
Tough Times for Startups
In the short term, the collapse of SVB means that there are less start-up focused lenders willing to onboard risky companies. This is particularly true for tech startups, which had found in SVB an ideal partner. These entrepreneurs are now scrambling to find alternative financial bakers. Most companies raising capital were facing new obstacles throughout 2022, including lower appetite from investor’s community, high cost of capital, and supply chain constraints deriving from China. Going forward, because of the recession risk, banks and investors will take their time performing due diligence on founders raising capital. Additionally, startups seeking venture debt will be offered less favorable terms than SVB would have provided, with debt issuers asking for larger equity ownership.
Furthermore, startups without a clear path to profitability might be forced to raise capital at a big discount and some may even be forced to shut down operations. For the least experienced earlier stage companies that survived the pandemic, 2023 will be an even tougher year. These founders should pursue lean go-to-markets, sell more equity at lower value, and get used to scarce and expensive capital.
Valuations will have to Change
Another consequence of the growing liquidity crunch is downward pressure on startup valuations. Tech valuations were insanely high throughout the Covid 19 pandemic, propelled by the frenzy around digital transformation and tech-based service delivery. Valuation inflation has thankfully stopped, driven by costlier capital (from 2008-2020 the cost of capital was close to zero) and technical recession pressure. As a result of valuation declines which accelerated in 2022, millions of companies around the globe have been dealing with “down rounds”. Down rounds happen when a company is forced to raise capital at a lower valuation than the previous capital raise. This depresses the value of the company shares, and it also hurts employee commitment and morale as these employees’ compensation included stocks and their shareholding is now worth less than before.
Everyone is Adjusting, so should Entrepreneurs
A worsening geopolitical and macroeconomic environment in 2023, means access to capital for early-stage companies will be scarce. Cracks in the financial systems are likely to show up in other markets as Deutsche Bank, Société Generale and BNP Paribas show signs of distress. Moody’s bond rating agency put half a dozen other US banks under review for possible downgrades. This may further destabilize capital markets and cause a recession both in the EU and in the US.
Entrepreneurs should stay vigilant and use this crisis to their advantage. Some of the strategies to avoid these systemic risk include: a) Introduce sustainability to their business model as this represents an large revenue source going forward; b) diversify your clients and suppliers across different geographies to ensure they can be agile during a market downturn; c) cultivate an internal culture of risk management and resiliency as this will help entrepreneurs absorb shocks and bounce back quickly when a crisis hit; and d) include more women in leadership roles as this is what the markets is going to reward under ESG regulations.
While there are positive trends developing in 2023, including lower inflation, lower supply chain constraints from China, and greater clean tech investment, there are “cracks” showing up across financial markets. The fall of SVB has no precedent, and its shock waves will continue to destabilize the markets increasing the risk of recession. Entrepreneurs should learn to do more with less, as capital will be tight and costly in 2023. Startups should seek to fund their growth with new revenues as opposed to expensive capital the market may offer. As we continue to live through crisis time, the Renaissance political philosopher and statesman Machiavelli has a good message that applies to entrepreneurs: “Never waste the opportunity offered by a good crisis”.Entrepreneurship
Articles from Andrea ZanonView blog
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