Preparing for the Investors Winter: Essential Survival Strategies for Early Stage Startups

The current investors winter has arrived, impacting industry giants and fledgling companies alike. Its effects are pervasive across all sectors, from technology to consulting. The banking industry is also reeling from the aftermath of Silicon Valley Bank‘s collapse.

What differs, however, is the approach adopted by businesses to endure and succeed in this bear market. Among different companies, approximately 50% choose to adopt a “freeze” strategy, exercising caution and patiently observing the unfolding events. Unfortunately, these companies are experiencing losses as their capital efficiency metrics continue to decline, making them less appealing to investors.

On the other hand, the remaining half of businesses have chosen a more proactive path. These companies will emerge from the investors winter stronger, capitalizing on the advantages presented by the “dry powder” accumulated by investors for the winners.

While the specific strategies employed by these future victors may vary, they all share a common objective: maximizing cash efficiency. In the following discussion, we will dive into these diverse strategies and demonstrate how both early-stage and late-stage startups can implement them not only to survive but also to thrive in this challenging climate.

Before we proceed, let us take a moment to gain a comprehensive understanding of the current venture capital (VC) landscape.

Emerging Patterns in the Present Venture Capital Landscape

In order to strategize their next steps, startups must first gain a comprehensive understanding of the current and anticipated business landscape. With the market experiencing a downturn that may persist until the conclusion of 2023, the dynamics of the venture capital (VC) game have undergone significant transformations, prompting VCs to reassess their investment approach. Let’s dive into several pivotal trends:

The Conclusion of the Valuation Bubble

The lingering impact of declining valuations in both early and late-stage companies from 2022 extends into 2023, impeding businesses from accessing crucial resources for growth. Additionally, the combination of elevated interest rates and challenging macroeconomic conditions has constrained the flow of cash to numerous companies, diminishing the rapid growth reminiscent of the dynamic growth witnessed two years prior.

Challenges Faced by Late-Stage Companies: Down Rounds, Expense Reductions, or Both

As a result of the prevailing devaluation trend, companies that secured funding at the peak of 2021 will encounter difficulties in maintaining such lofty valuations in the current market. In 2023, raising funds at a flat or down round will no longer carry the same negative connotation as before; instead, it may be the only viable choice for those striving to survive. Similarly, implementing cost-cutting measures to prolong the company’s runway at the expense of immediate growth has become a necessary strategy.

Increased Due Diligence Leading to Funding Delays

The consequences of the pervasive fear of missing out, which has been prevalent in the venture capital (VC) industry in recent years, have become evident. As a result, investors are now adopting a more cautious approach. In 2023, VCs are no longer swayed solely by attractive growth prospects and instead, they are subjecting their portfolios to rigorous scrutiny, leading to extended deal timelines. To navigate this new landscape and successfully secure funding, companies seeking capital must demonstrate financial preparedness to accommodate delays and prove themselves beyond having just a groundbreaking idea.

Minimized Investment in Pitch Deck Time

In the initial months of 2023, investors allocated a mere 2.5 minutes per pitch deck, marking the shortest duration observed in the past five years. Nevertheless, corresponding statistics indicate that investor interest in deals has rebounded to its 2021 levels, underscoring the heightened significance of creating a favorable initial impression.

Low-Risk Stocks Regain Prominence

Amidst volatile market conditions, an increasing number of Venture Capitalists (VCs) are choosing secure investment avenues that offer assured returns and greater control, veering away from high-risk, high-reward stocks. The advantages of senior securities have now eclipsed those of standard convertible preferred stock and pari passu series, indicating a notable transformation in investors’ perspectives and priorities.

Essential Survival Tactics for Navigating the Investor Winter

Since the investors winter began to cool down in the latter half of 2022, Waveup has had ample opportunity to observe the various approaches adopted by different venture-backed companies, including their clients, in response to the situation.

The ensuing “strategies of the future winners” stem from their experience and concentrate on extending the runway, enhancing unit economics, and attaining a more secure position. Additionally, these strategies are designed to ensure inclusion in the priority list of venture capitalists for upcoming fundraisers, both in the present and when the market experiences a downturn.

Enhancing Capital Efficiency: Maximizing Resource Utilization

Capital efficiency is a metric that assesses the effectiveness of a company’s cash utilization by comparing the amount spent on growth to the corresponding returns.

Given the deceleration in cash flow for businesses, even minor monetary leaks that were previously inconspicuous can now rapidly deplete a company’s resources. While generating revenue is crucial, it may not suffice for survival and competitiveness in today’s turbulent economy without judicious management of capital expenditures. Recognizing this, investors have adjusted their criteria to favor robust capital efficiency indicators over exceptional growth rates.

To enhance capital efficiency, it is imperative to gauge your current position and identify areas that can be optimized.
Presented below are four key capital efficiency metrics to monitor:

1. BVP Efficiency Score: This high-level metric provides a simple evaluation of your revenue as a return on capital expenditures. To calculate it, divide your net new ARR (Annual Recurring Revenue) by your net burn within a given year. A desirable score should aim for a minimum of 0.5x, with an exceptional result exceeding 1.5x.
   
2. The Rule of 40: Specifically applicable to SaaS companies, this metric assesses a company’s combined revenue growth rate and profit margin. It is calculated by summing these two factors. As the name implies, a healthy benchmark is to meet or exceed 40%. Maintaining this rate becomes more challenging as your company grows.
   
3. The Magic Number: A widely recognized metric that measures the efficiency of your sales team by determining the amount of revenue generated for every dollar spent on sales and marketing. A magic number below 0.5 indicates room for improvement and prompts a reevaluation to achieve a minimum of 0.75 or higher.
   
4. CAC Payback: This popular measure indicates the time it takes for your company to recover the costs incurred in acquiring new customers. The formula may vary, but for subscription-based businesses, the most common calculation is as follows: Average CAC (Customer Acquisition Cost) per customer divided by (Average MRR (Monthly Recurring Revenue) multiplied by Gross Margin as a percentage). The benchmark for this metric depends on the nature of your business. In the B2B sector, investors typically prefer to see a payback period of 12 months or less, with eight months being an ideal outcome. B2C businesses tend to recoup CAC faster, although benchmarks may vary across different industries.

Eliminating Unnecessary Costs

During economic downturns accompanied by declining revenues, businesses can implement various cost-cutting measures. As growth takes a backseat to stability, certain expenditures become superfluous and can be curtailed. However, it is crucial to strike a balance and avoid excessive cost-cutting by adopting a strategic approach.

The following steps can assist in this endeavor:

• Perform a comprehensive expenditure audit: Collaborate with your accountant or conduct an analysis independently to review your monthly financial outlays. Identify areas where spending can be reduced without adversely affecting your financial performance. Engage in discussions with your teams to determine potential subscriptions, services, media or networking groups that can be temporarily paused or downgraded. Similarly, evaluate office expenses like phone services, utilities, and equipment, seeking opportunities for cost optimization.
  
• Engage in negotiations for improved terms: Depending on your business nature, proactively negotiate with office or storage providers, suppliers, and banks to secure preferable terms. Explore possibilities for decreasing rates or, at the very least, locking in current rates. Additionally, consider extending payment windows to allow for delayed payments and maintain healthier cash flow.
  
• Exercise caution when considering workforce reductions: While the temptation to downsize to preserve costs may arise, approach layoffs judiciously. Take into account the substantial expenses associated with hiring and training new personnel. Be mindful that some employees may provide valuable contributions that may not be immediately apparent but are significant to your organization. In many cases, exploring alternatives such as granting leaves of absence may prove to be a strategically superior approach to expense reduction.

Prioritize Revenue Generation: Directing Attention to Income Growth

Even in times of economic downturn, it’s crucial not to halt your revenue-generating efforts or completely forsake your growth aspirations. Instead, consider recalibrating your strategies to prioritize generating immediate cash flow.

Here are some suggestions to achieve this:

• Prioritize customer retention: Recognize the importance of retaining existing customers over acquiring new ones, as they contribute more to your revenue. Focus on reducing churn by conducting both quantitative and qualitative research, implementing loyalty programs, gathering customer feedback, and delivering exceptional post-sales support.
  
• Evaluate and adjust pricing: Many businesses we collaborate with are considering price adjustments or changes in pricing models to generate immediate growth and offset any decline. Explore options such as shortening free trial periods, charging extra for advanced features, introducing diverse packages with varying features and prices, or simply raising your prices.
  
• Review your marketing strategies: Research indicates that businesses that maintain their marketing efforts during a recession achieve the highest sales records compared to competitors. However, it’s crucial to find more effective ways to expand your market share. Reassess your marketing strategy, abandon ineffective channels, and focus on those that yield positive results. Don’t slow down the engine of your marketing activities.
  
• Explore additional revenue streams: Look into expanding your customer base in new markets to compensate for lost clients or adapt your product/services to industries poised for growth. This exploration can lead to new opportunities for generating revenue.

Expanding Funding Sources: Embrace Diversification

When venture capital becomes costly and less accessible, extending your runway is crucial, but it’s also essential to maintain flexibility in funding options. Several of the early-stage companies we collaborate with have started exploring or contemplating alternative avenues for securing funds.

They include:

• Bridge financing
• Debt
• Consolidation
• M&A / strategic partnerships

While not all options may be optimal, it is crucial to have a contingency plan to access funds in this unpredictable market.

Embrace Adaptation to Achieve Success in Evolving Priorities

The future of the markets is unlikely to witness a swift recovery in the upcoming year. As is the case with any crisis, those who can swiftly adapt to new circumstances will emerge as the strongest contenders. In this scenario, the victors will not only weather the economic turbulence but also capitalize on the opportunities available to those who comprehend and adhere to the new rules.

Waiting out the storm will yield no progress. Instead, adopt a winning mindset and take proactive measures: Stay vigilant regarding your key metrics, enhance capital efficiency, employ strategic and disciplined capital management, prioritize revenue-generating activities, and diversify your funding alternatives. By doing so, you will maintain control and position yourself for long-term success amidst this volatile environment.