Early Stage VC June 2022–No, The Sky Is Not Currently Falling

This post is by John Eng, RSCM’s Director of Funding Ecosystem. He stays in constant contact with other investors so that we can effectively advise our portfolio companies on their subsequent rounds.

How has the recent tech downturn affected early stage VCs investment? Undoubtedly, all startups are asking themselves this question. Should they go for the seed or Series A round now or should they buckle down and raise a smaller round from existing investors? Our poll of Seed and Series A VCs reveals that these stages remain relatively robust, though tempered by more historically realistic expectations.

As I’m writing this, VC Twitter is foreshadowing doom and gloom. Is a recession imminent? Does it feel more like the dotcom bubble of 2000 or the housing bubble of 2008? Some big high-flying growth stocks have dropped by 75% to 90%. Public SaaS multiples dropped from a high of 17x to a low of 5.6x. When will we see tech stocks bottom? What’s the right valuation to pay for growth?

Based on VC Twitter, it sure seems like the sky is falling. Many well-known later-stage and growth-stage VCs have published “crucible-moment memos” about operating during a downturn–extending runway, get to default alive, get to default investable, expect valuations to come down, etc.

But what about early-stage companies? At Right Side Capital Management, we invest at the earliest stages. Our portfolio companies are typically concerned more about the early-stage investment climate, rather than later-stages that feel a more direct impact from public market turmoil. 

Can startups still get Seed or Series A investments? Well, we tried to answer this question. We conducted an informal survey of Seed and Series A investors the week of May 21 2022. Roughly 70 responded. We asked questions like:

  • Are you still investing in new portfolio companies? If so, is your rate of investment higher, lower, or the same as it was prior to the recent tech downturn?
  • Have there been any changes in your investment themes / strategy that I should be aware of? For example, are there any new sectors you are focusing on or avoiding, or have there been any changes to the traction levels you are looking for at different stages (ie. Seed, Series A, etc.)?
  • Are there any other ways the recent downturn has affected your investing?

The results didn’t surprise us. The sky does not appear to be falling (at least yet) in early stage fundraising.

Key takeaways:

  • Early stage investors are still very active. Everyone responded that they are indeed still investing and busier than ever. Some (20%) are more cautious and are slowing down their pace of investment. And a few (6%) are opportunistically increasing their pace of investment.
  • Not many have changed their investment criteria. Those that have are just moving to earlier stages (i.e., to seed from Series A) and moving away from cyclical businesses.
  • The bar is higher now. Investors are being more selective–a higher bar in terms of both revenue and unit economics. Investors are taking more time for due diligence now that deals are less competitive, digging more into business fundamentals before committing. They are asking companies how their businesses will be impacted by an economic downturn–growing inflation, higher interest rates, slowing consumer demand.
  • Early stage investors are expecting lower valuations in Seed and Series A and are excited by it. They are already seeing a slow-down and lower valuations in Series A. They anticipate the same for seed-stage fundraising before long. Many investors who have been passing on high valuation deals are anticipating a faster pace of investment as valuations normalize. Some startups seeking Series A rounds may end up being disappointed in the valuations they receive (or don’t receive) and will need to raise bridge rounds to stay funded.
  • Reserving more capital for follow-ons. They expect bridge rounds to become more common and are therefore shifting their allocation to accommodate that need within their existing portfolio companies. That means less capital available for new investments, which has to mean either less Seed and Series A rounds get done or that round sizes are smaller (or both).
  • Spending more time advising their portcos. Startups that used to go 12 to 18 months between rounds are now expected to go 18 to 24 months before their next funding round.  As a result, investors are more engaged than normal with their portfolio companies helping them plan and adjust for this new reality. Survival, runway extension, and optimizing for unit economics is now the primary focus for most existing portfolio companies.

We understand that the changes at later stages should eventually trickle its way to earlier-stages. Some say it might happen in a month or two. Some say it might take longer.. However, the good news is that, for now, the early stage funding environment is still alive and open for business. VCs still want to meet founders. They still want to invest. The bar is higher. Valuations are lower. Due diligence is stricter. The Seed and Series A markets are not dead, they have just quickly reverted to what used to be considered normal conditions. This means early stage founders will need to adjust and become more realistic. 

We will continue to keep our eyes and ears open. I’d welcome your comments and news.

Survey Results

Are you still investing in new portfolio companies? If so, is your rate of investment higher, lower, or the same as it was prior to the recent tech downturn?
No changePace IncreasingPace decreasing
57415
Have there been any changes in your investment themes / strategy that I should be aware of? For example, are there any new sectors you are focusing on or avoiding, or have there been any changes to the traction levels you are looking for at different stages (ie. Seed, Series A, etc.)?
No change to criteriaChanging criteria
675
Are there any other ways the recent downturn has affected your investing?
No changeHigher Bar DDSeeking lower valuations
39919
Focusing on different stageMore follow-on dealsMore bridge rounds
341
Seeking longer runwaySupporting portcos moreFewer, bigger deals
241

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