2022: Do Founders Have An Answer For Downrounds?
I’ve been intrigued by a report on PitchBook over the pullback in venture capital for large check-seekers. The article in question was posted in my last post about downrounds for fundraises in 2022.
Does it mean growth capital for startups stop in 2022? NO. Rather investors are assessing the global recessionary climate due to the Russia-Ukraine war and post-Covid fallout. They’ve become more picky in who they fund, and how much money they allocate.
WHERE DOES THIS LEAVE STARTUPS IN 2022?
It leaves them for lower valuations, which means less money for more equity. If they’ve raised more for less equity previously, this is a downround. It punishes their earlier investors because they’ve taken a hit on their potential exit returns.
As a Bangladeshi startup founder, structured terms with investor-friendly term sheets are nothing new. We are a frontier market, and we’ve made it a habit of making it hard to justify the same valuations other markets have gotten. It’s a way for good capital to enter into a bulging market, and for investors to protect their downsides.
DO FOUNDERS HAVE AN ANSWER FOR DOWNROUNDS?
You can answer downrounds by focusing and maintaining cashflow positivity. ‘Growth at all costs’ is taking a backseat. This was a given in the Bangladeshi startup scene anyways because of the difficulties of product-market fits. It was mildly amusing to read about the ‘Rule of 40’ in the Pitchbook report when Bangladeshi startups have been operating under structured capital usage from the get-go. Basically, the ‘Rule of 40’ says growth combined with profitability should be more than 40%. I would add to profitability and maintain that cashflow positivity is equally as important when external capital injection isn’t coming. If you make enough money to sustain your own spending, your company is not only leveraging it’s cashflow positivity to investors, but also riding the tide of a dry financial market. If nothing, your company is in good health and can actively expand and grow. This will enable other forms of capital to open up, such as short-term borrowings.
Good money follows good companies. In a financial downtrend, market confidence dips so investors reign back on spending. This ‘confidence’ issue can be mitigated if you’re profitable, solvent and liquid enough to run business operations. In my opinion, if you’re unwilling to spend in a downtrend, you may look for the best in a bad market to invest before the uptrend. We’re in a downtrend in 2022, and capital markets are getting picky. That’s not to downplay the overall upward trajectory if you zoom out: venture capital has grown to a $211.3 billion industry in 2021 and is projected to grow at 20.1% CAGR till 2027. It’s just that we’re getting off a pandemic and in the midst of a war, and that’s a pretty good reason for a ‘funding winter’. But founders: yes, you do have an answer for a downrounds.