There is always information asymmetry between founders and VCs, but the current market slowdown has thrown that even further off-balance.
When we speak to founders recently, we’ve noticed even more misunderstandings about investor expectations and behaviour. Many haven’t quite caught up with where investors’ heads are at. And through no fault of their own, markets and investor mindsets have changed quickly.
As more companies are starting to fundraise or test the waters — we’re starting to see things pick up pace after a slow start to 2023 — here are some of the mistakes we see founders making when going into fundraising.
Misinterpretation of signals
“We see a significant investor interest so we might pre-empt and raise earlier” is a phrase we’ve heard a lot recently.
Yes, every early-stage VC is eager to meet and talk to companies that have revenue and are growing. At the same time, founders should be aware that being courted by VCs does not guarantee an investment by any means, especially if key milestones are not being met.
Funds did less deals last year than in previous and are indeed eager to deploy. Still, capital has certainly become more selective.
To understand whether the VC is actually seriously interested — and a fit for you and your company — ask the VC early on what they would need to see to actually proceed with investing. For Series A, that might be the first international customers or specific ARR (annual recurring revenue) targets.
Forgetting we’re not in 2021 anymore
“We expect a premium on our last valuation because we have progressed well,” some founders tell us.
A flat round is an option as well and is seen as 'normal' in today's market; two years ago it would have raised questions
A fair assumption, but with a caveat. If your last valuation was set during the peak of the tech cycle in 2021 in a competitive, maybe even pre-empted round, your traction was almost certainly not aligned with your valuation at the time.
In such scenarios, funds often cannot justify a (significantly) higher valuation if the company has not managed to grow into and exceed the previous valuation.
If this is the case, there are several options depending on your situation. If you are about to hit some milestones in the next three to nine months, raising a convertible loan from existing investors is likely the best option and provides the option to raise at a better valuation once you can demonstrate progress to potential new investors. A flat round is an option as well and is seen as "normal" in today's market; two years ago it would have raised questions. We will also see downrounds — when the company raises at a lower valuation — when an internal round or a flat one is not an option.
An unwillingness to accept the new reality
For all the founders out there aggressively fundraising, there are the ones who say: “We do not want to raise now because of low valuations.”
Founders should not expect 2021 valuations to return any time soon. As the market reflects on 2021’s unhealthy premiums — often as high as 50x ARR at Series A or even higher — it's important to set reasonable valuations that reflect the potential exit size and how de-risked the company is. At Series A, most companies should expect multiples in the range of 7-15x on their forward-looking ARR. In today’s market, adding $500k or $1m to your ARR is more important than ever.
Founders should only look to public markets to temper their enthusiasm
In hyped markets with strong growth — such as generative AI or MLops currently— we are seeing that founders can still push for higher valuations. In these cases, founders can command a valuation of 15-30x on ARR at Series A or raise pre-revenue seed rounds with valuations at 40m or higher. But those are still not in the realm of 2021.
Founders should only look to public markets to temper their enthusiasm. Multiples of the top-performing listed software companies have been adjusted down by 70%. The private market is still digesting the valuation adjustments seen in the public market. It's happening, but it's happening slowly.
Don’t get me wrong. This is still very much a phenomenal time to build enduring companies. Talent is moving, compensation has become more reasonable and investors are eager to invest. But founders should stay realistic and accept that fundraising has changed.
Eva Arh is a partner at 3VC.