I’m writing this on May 20, 2022 after a pretty sunny but tiring week in SF.

Why tiring?

3 days ago, Michael Seibel, the CEO of Y Combinator sent a (now leaked) message to YC founders. Multiple founders have forwarded it to me along with the same anxious question – “IS IT GOING TO BE THIS BAD??”

Since this came out, I’ve talked with a handful of VCs and over a dozen founders. I had my own opinions on how things will play out but it was helpful to get other perspectives.

You can trip in the Twitterverse and fall into a dozen different VC predictions on what happens with the market. I’m throwing my own in the ring, but as always, I’ll try to share my take with a more specific tactical lens related to fundraising.

My personal take / prediction: 

We’re definitely going through a slowdown (both pricing correction and deal velocity) in the early stage private markets where I spend all my time.

Global wars, inflation, and other macro forces are influencing investor sentiment. More specifically, this has had a huge hit on the collective investor psyche:

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Yes, the public markets have been hammered. But why exactly is that impacting early stage venture capital?

Impact of Public Markets on VC

There are multiple reasons public markets impact venture capital. The 3 that most influence fundraising as a founder are:

1. Investor wealth = YOLO – many investors have positions in the public markets to diversify outside of their index around early stage venture. Whether it’s because of direct personal investments or exposure via mutual funds / 401k indexes, the public market has a very palpable effect on an investor’s personal wealth and security. When wealth and security surge, so does an investor’s willingness to throw caution to the wind… or YOLO. I guess the cooler term would be ‘ape’. When investors feel rich, they are more likely to ape into deals and be less price cautious. In a market downturn, wealth and security take a major hit along with the aggressive, uncontrolled investing that tends to benefit founders.
2. The strength of M&A currency – for a venture style outcome to occur via M&A, the acquirer most likely needs to be a large public company. The public markets can be an insight into large acquirers’ appetite to spend. Healthy multiples means a healthy impact on stock price by acquiring a startup’s revenue. Also, acquisitions by public companies are often done using public stock. It is the currency of acquisitions so the value of that currency impacts how aggressive companies will be acquiring companies.
3. The IPO market – going public is the ultimate goal of the typical venture-backed startup. It represents the chance to provide liquidity to investors at the highest possible level while also maintaining independence. If a market is trading high and pulling up multiples for industries that your startup is in, the expectations of what could happen in the future rise. It can be easier for a VC to justify certain valuations by looking at the public market multiples and anchor there. So if the public market is doing well, this logic will help pull private valuations up and vice versa. 

But does this make sense?

No. It’s irrational

The direct reaction to the public market is irrational, especially for early stage venture capital. The average time from initial venture capital investment to IPO is 5.7 years (source). So unless you’re specifically concerned about investments that might try to IPO in the next 11-17 months (the disputed average length of recessions: source 1, source 2), the current market downturn shouldn’t be slowing down an investor’s Pre-seed through Series B investing. 

So how is this still happening? 

The cleanest answer is uncertainty. Uncertainty is causing irrational pullback from investors even though there are still great opportunities to invest. The VC community is a herd and the herd is spooked. The same way the herd charged in together and drove sky-high prices that defied logic over the last two years is the same way they have started to irrationally sit on the sidelines.

But all is not lost. There is still a ton of dry powder (uninvested capital) in the PE and VC markets that need to be deployed over the next couple of years. That means after investors take their first fairly normal summer vacation since 2019 (many are using it as an additional excuse to wait out the current market volatility), deals will start picking back up in the fall.

What else should we expect?

When VC investing picks back up in the fall, valuations won’t look the same…

Investors had their sober reality check via public market smackdowns and doom & gloom notes like the YC one above. The last two years of sky-high pricing are finished with valuations coming down across the board. 

Three main comments re: valuations:

1. Top tier deals – There is still a ton of capital that needs to be invested and with that the top 5% of deals will be quite competitive. I anticipate valuations to come down slightly there but be bolstered by the flight to quality. Founders running companies with real traction and momentum will maintain pricing power
2. The end of yolo pre-seed pricing – Over the past year, I saw an insane number of deals that were just teams with a deck raise rounds on SAFEs with caps between $50-100MM. Most of these were web3 companies whose plans for a token put near-term liquidity dollar signs 💰💰 and Solana-style rocketships 🚀🚀 in investors’ eyes. This had an inflationary effect on web2 pre-seeds as well. It wasn’t rare to see $15-25MM for a pre-seed. RIP and good riddance to this (more on this later)… The crash of UST and crypto in general has injected greater levels of restraint into the investor community. Even web3 deals will be held to a higher bar when valuations are set.
3. The return of 2019 – Overall I think prices will return to 2019 levels. Broadly speaking, that means $4-10MM Pre-seeds, $8-15MM Seeds, and $12-25MM Series A’s. A few entrepreneurs have been shocked and disheartened at hearing those prices. When I get that reaction I remind them of just how healthy 2019 prices were. $8MM for a company you just started 3 months ago? That’s incredible! The very first Series A deal I was involved in way back in 2013 had an experienced entrepreneur founder, a team that worked together before, and $1MM in annual revenue. We did that deal at an $8MM pre-money valuation. The return of 2019 is not a death sentence – it’s a return to some reasonableness from the perfect storm insanity of 2020-2022.

What can I do as a founder?

A few notes on tactical fundraising advice as a founder. 

1. Fail fast – If you are currently raising, go quickly and fail fast. The sands are shifting beneath you so you have to push to get something done before the summer slowdown sets in.
2. Reopen your round – those investors who didn’t make it into the round you closed a few months ago? Consider letting them invest at the same terms. If you raised anytime in the last 2 years, you likely did so at a really healthy cap / valuation. The market will not be as generous at your next fundraise and you’ll need to have grown past that last mark to raise your next round. If you think you might need more time, go try to get it. It doesn’t need to be a full process. Send a few targeted notes with your progress updates and a calm but honest nod to wanting to de-risk the market by taking on a little more money.
3. Time kills deals – Now more than ever, time will kill deals. Verbal commitments will evaporate before your eyes with checks either shrinking in size or fully withdrawn. Collect checks immediately and stay on top of the investor who gave you a commitment. You’ll be pressuring their sense of duty / commitment / guilt in order to wrangle those dollars.
4. Hold your breath instead of raise – Who knows? It could get worse but I would bet on the fall being a better time to raise than right now. If you don’t have momentum coming into a May/June fundraise, pause your plans and hold your breath to make it to September. That might mean making some cuts, slowing things down, etc, but do what you can to hold off on raising till after August. Use the summer months to generate momentum and awareness, then take your shot in the fall.

Overall I’m optimistic. There’s still lots of building to do and I’m excited to see founders recommit to building companies with sound fundamentals, those that can last without endless streams of investment to prop up bad business models and shaky operations.

If you can survive the coming winter and even collect capital (remember there will still be a ton of investment activity!), you will be in a fantastic position to accelerate into the next bull market.

Good luck and I’m looking forward to helping.