The Sky is Falling! ...or is it?
In recent weeks, public markets have fallen dramatically, high-flying startups have had significant layoffs, and VC talking heads are rushing to proclaim that the good times are over. But is the sky really falling? And, if so, what should you do about it?
First a bit of an explanation of what’s going on:
In recent weeks, public markets have fallen by more than 20%. I won’t explain why (since that’s a whole other rabbit hole), but it’s causing a domino effect deep into Startupland:
When public markets pull back, companies that were planning to IPO put those plans on hold. This causes late stage investors (Series C and later) to change their behaviour for the two reasons highlighted above:
Their investment decisions are driven in large part by calculations around time-to-IPO, and that math is now unclear
They must determine whether or not they need to redirect additional capital to existing investments in order to prolong their runway and spend time supporting those founders as they navigate a new reality
The change in late stage investor behaviour cascades down to earlier investors (Series A and B) as their pace of investment slows down. Rounds take longer, are less competitive and result in lower valuations (which is less exciting to both startups and their investors). Eventually, this comes all the way back to the early stage market.
“But Chris!” you ask, “I keep hearing about how VCs have all sorts of dry powder.”
It’s true — in recent years, VCs have raised more money than ever before. But here’s the thing…that money isn’t actually in our bank accounts 🙈
Unlike startups, when VC funds raise money, we get commitments from investors (not actual 💰). The money is later wired as installments over time — typically 3 - 4 years. Those commitments are normally solid, but when public markets fall quickly cash flow can become an issue for individual investors and corporations alike. Believe it or not, it isn’t uncommon in a downturn for VCs to “call capital” from investors, only to have some of them default on their commitments.
This isn’t something that’s normally talked about because, even when it does happen, it usually isn’t a big issue. But over the past few years, there’s been an explosion of new funds, especially in the sub-$25M range (solo funds, operator angels, rolling funds, etc.). Unlike established funds like Panache, new VCs depend almost exclusively on individual investors and, as a result, are disproportionately impacted by the uncertainty caused by economic downturns. This can lead to liquidity issues, causing those funds to slow down their pace of investment.
So what we’re seeing play out across the investor landscape right now is akin to what happens if you’ve been driving your car at top speed in the pouring rain (a bit reckless, right?). Suddenly, you see brake lights from a slowdown up ahead and quickly pump the brakes to avoid crashing, with everyone else around you doing the same. Eventually, we’ll all come to a stop, take a breath, and get going again, but right now the cars are still skidding around.
So what does this mean for you, my dear founder?
1. Don’t be Cute
First off, this isn’t the time to be cute. While it’s entirely possible that this will blow over, all signals indicate that the downturn we’re currently witnessing will be measured in months, not weeks. So if you’re currently in the middle of a fundraising process, I recommend that you close your round as soon as possible. Don’t play games, get the money in the bank.
2. Hold Off on Fundraising
If you were thinking about fundraising but have the runway to delay, consider holding off until the fall. The current uncertainty will, at a minimum, cause rounds to take longer (leading to less competition and lower valuations for most companies), so you’re better off waiting until everything settles down.
If fundraising wasn’t on your radar to begin with (either because you recently raised or are cash flow positive), then tune out the noise, put your head down and get to work. It may even be an opportunity to get aggressive while others are pulling back.
3. Extend Your Runway
Every founding team should talk candidly about things they can do to extend their runway. Most founders today (and many investors, for that matter) have never been through a prolonged economic downturn. In a real downturn, not only can it be harder to raise funding, but customers can downgrade or, worse, simply stop paying.
When the 2008 financial crisis happened, a major US bank with whom we had a 7-figure contract called us up and matter-of-factly stated that they were not going to pay us. They knew it was a breach of contract but they also knew we could not afford to sue them.
Damn.
These things really happen and, when they do, they happen fast. So take the time to think about ways to extend your runway and get ahead of the market. That can mean cutting costs. It can mean enticing monthly customers to pre-pay for annual contracts. It doesn’t mean you should panic, but in a downturn, cash is king.
So what are we doing at Panache?
We haven’t slowed down our investing, that’s for sure. As Pre-Seed / Seed investors backed by some of Canada’s largest institutional LPs, we’re relatively isolated from shifts in public markets and continue to invest in promising companies across the country (in fact, we signed our latest investment yesterday).
However, we’re also taking the time to check in with all of our portfolio founders as they navigate this new reality.
Last week, we did a full top-to-bottom review of the 100+ companies in our portfolio to understand where each company is in terms of runway. We then reached out to all of those with 9 months or less to see if there’s anything we can do to help. Over the coming weeks, we’ll hold calls with founders across Canada to share our perspective on what’s happening and what actions (if any) they might want to consider.
The fact remains that no one knows how long this downturn will last. Are the brake lights up ahead a brief slowdown or a serious traffic jam?
My personal mantra is “hope for the best, plan for the worst” and while we wait to find out, this is a great time to do just that.