Early stage investment is just as hard as it has always been
Raising money is hard. Founders have always struggled to raise their first first round. There are more investors, there is more capital, but it is still difficult to convince investors that your company is able to break through and generate the returns they want.
“plus ça change, plus c'est la même chose” – Jean-Baptiste Alphonse Karr
Fundraising process has stayed remarkably similar, and challenging for founders. But technology, technology adoption and the expectations of customers is in a constant state of flux and evolution. This creates new opportunities but the early signals can be difficult to see and just as difficult to explain to investors, many who are only seeking yield.
Finding the investors who will invest the time to understand early signal, build strong connections with your potential customers, and focus on building your business is difficult. It requires insight, conviction and investment that is often intangible or not seen on the cap table. It’s far easier to convey hurdles/baseline expectations in performance metrics (like MRR or number of customers), and the size of finance rounds, and hope that the best entrepreneurs figure it out.
The sky is falling, the sky is falling
The market reality changed with COVID in 2020. And just like that it changed again in 2022. All of the gains and growth that remote work and ecommerce brought through the pandemic, has been erased. Gone are the heady days of uncapped tokens and unbridled valuations. We are back to more rational times, with more pricing discipline as we navigate uncertain waters for companies that don’t make sense yet.
What could change is just how many employers jump on this excuse to lay off people and adjust their spending and if that, along with everything else going on, does result in a real recession (negative GDP).
What does that mean for early stage founders?
Stuff is still hard.
Valuations are returning to more practical levels.
Capital efficiency to avoid future pain
The positives are big as this is creating an opportunity to attract talent, exploit the distracted bigger companies to establish yourself in the market, and be the darling of new investment funds that know the biggest winners are born in down times.
Stuff is still hard
C.R.E.A.M - Cash Rules Everything Around Me. There is only one reason companies go bankrupt, they run out of cash to pay the taxes, their employees, etc.
It is unusual for founders to have an endless supply of capital (and time).
“a startup is an organization formed to search for a repeatable and scalable business model” – Steve Blank
Founders are starting a company in order to build something and trying to sell that something to other people. They are trying to figure out if what the company is doing works. Will anyone invest? Will customers buy? Can we hire a team? Everything is great and not-great at the same time. It is a search with moving targets in customers, customer needs, product development, business models and the expectations of investors.
How do you convince someone to invest in you? Or the company? It’s a lot easier if you’ve sold a company that they were an investor in and they made a lot of money. That’s a pretty strong signal that you know what you’re doing and you can do it again. But if you’re a first-time founder, it is difficult to convince someone to invest in you.
Trying to convince someone to invest in you because of an investment in someone else you read about in BetaKit or TechCrunch. That’s like saying I should buy a Ferrari because I saw someone that I aspire to be like driving one on Instagram, it sounds crazy. Yes, people raise money. Yes, people write stories and provide news coverage about raising money. But other people’s stories will not convince investors that you are an investment that will succeed.
What has always has and always will stand out is a founder (and team) that has an ambitious vision, practical execution plan, and a deep understanding of their customer.
And the expectations have increased. Investors are expecting targets and metrics that are 3x greater in Jun 2022 than they were expecting in Feb 2022. You need a plan to build a successful business. And you need to be able to communicate where you are, where you are headed, and how you measure progress in a clear and concise way.
Valuations are returning to more practical levels
Figure: Average round sizes in Canada according to Briefed.in grew to $781k pre-seed and $4.1M seed in 2022.
So what is normal? Normal is different in different places. At the pre-seed stage in the Valley, the new “normal” is $750k-$1.5M raised on $5-$7m valuations. In Canada, the amounts raised and the valuations, according to Briefed.in data, are between $500k-$1M on $2.5-5m valuations.
With great power comes greater responsibility
The size of the round raised can be a great scorecard. It makes it easier to compare the success of your fundraise to others. It’s easy to measure success based on the size of the round. Mine is bigger than yours. But it might not be the best evaluator of current success or future potential.
Large early rounds have implications for founders beyond funds raised. Large early rounds set expectations for growth that can be difficult to achieve in uncertain markets and can set founders up for future pain.
Founders that are able to use less money to prove their product/market fit and build momentum are going to be well positioned for the future capital. The money behaves in a certain way, there is a strange, almost irrational logic to timelines the need for growth (and returns). Understanding the new goalposts and expectations of investors are key to building a plan. Smaller faster rounds, focused on execution will allow founders to be prepared to fundraise when valuations climb in the future.
Focus on the opportunity ahead and build
It’s so much easier to compare yourself to an artificial ideal. It’s almost impossible not to make inferences about other people’s financing rounds, particularly given our fascination with covering them in the press, and to then use inference as the measuring stick for your company, your customers and your future performance.
Don’t be distracted by the flippy flippy spinny spinny and chuck a spreadie to the gods by other people’s financings. There is a different, better way to avoid destination F’d.
Focus on customers that are ready to change their behaviour now. There is an abundance of business pain and customer motivation out there, go find it, ease the pain and find product-market fit. The money will follow. Money needs growth. Growth is about customers. Don’t assume that someone else’s money will help you solve a customer’s problem (though it might help convince them to pay you, maybe).
Focus on the execution of a market with enough customers that have enough pain, that they are willing to change their behaviour and use/pay for your product offering, despite all of the flaws. Then find investors that will work with you on this journey and help you find success. Experienced investors are going to appreciate the drop in the noise and the increase in quality. They know big opportunities could be found now and they take time to build.
At Eigenspace we always hope we can compress time to help founders find success early but we know it takes time to find overnight success. If you are a founder raising your pre-seed or maybe you just did, we would love to talk to you and see if we can help you navigate the current climate and find success.