How Early-Stage Startups Can Survive and Prepare for the Investor Winter

The investor winter is here, and it is hitting both industry moguls and early-stage companies hard. No sector remains unaffected, with layoffs spreading from tech to consulting, and the collapse of Silicon Valley Bank sending the banking industry scrambling.

What varies, however, are the approaches businesses take to stay in the game and survive in the bear market. Half of the companies I work with take the “freeze” strategy, biding their time to see what will happen next. So far, these companies are losing — their capital efficiency metrics continue to plummet, making them less attractive to investors.  

The other half of the businesses have taken more proactive routes. These companies will come out of this funding winter stronger, enjoying the benefits of the “dry powder” investors have stored for the winners.

The strategies these future winners use may vary from company to company, but they are all geared toward one thing: being as efficient with cash as possible. Here, I will explore the different strategies and how both early- and late-stage startups can implement them to not just survive, but thrive in this climate.

But first, let’s take a moment to understand the current VC environment.

To figure out their next moves, startups must first get a good grip on the environment we are operating in now and likely will be for the foreseeable future. As the market has seen a downturn that could last until the end of 2023, the rules of the VC game have changed accordingly, forcing VCs to reconsider their approach to investing. Here are a few key trends:

The valuation bubble is over

The 2022 decline in both early- and late-stage valuations continues to persist into 2023, cutting businesses from the much-needed food for growth. Moreover, high interest rates coupled with the harsh macroeconomic reality have made the cash tap run slower for many companies, depleting them of that steroid-like growth we witnessed two years ago.

Late-stage companies have to down round, cut expenses, or both

Due to the devaluation trend, those companies that raised at the height of 2021 will have a hard time commanding such a steep price in the current market. In 2023, raising a flat or down round won’t be as “frowned upon” as it was before; in fact, it might be the only option for those who want to stay afloat. The same goes for resorting to belt-tightening tactics to extend the runway at the cost of growth.

Funding delays due to harder due diligence

The implications of the fear of missing out that dominated the VC space in the past few years have made themselves clear, pushing investors to be more cautious. In 2023, VCs refuse to be blinded by shiny growth opportunities and will rigorously scrutinize their portfolios, stretching deal timelines. To survive the wait and pass the background check, companies looking to raise capital must be financially prepared to fund delays and make sure they have more than a groundbreaking idea.

Reduced time spent on pitch decks

During the first few months of 2023, investors spent 2.5 min per pitch deck, the shortest amount of time in the past five years. However, according to the same statistics, the strength of the investor appetite for deals is back up to its 2021 levels, so the importance of making a good first impression is higher than ever.

Low-risk stocks are back in fashion

Rocky market conditions force more and more VCs to opt for secure types of investments that guarantee them returns and control over high-risk/high-reward stocks. The benefits of senior securities now overturn those of standard convertible preferred stock and pari passu series, demonstrating a significant shift in investors’ mindsets and priorities.

Key strategies to survive the investor winter

Since the investor climate started to turn cold in the last two quarters of 2022, we at Waveup have had enough time to observe how different venture-backed companies, including our clients, have approached the situation.

The following “strategies of the future winners” come from our experience and are focused on stretching your runway, improving your unit economics, and getting into a more secure position. They will also get you on the VCs’ priority list for the next fundraiser now or when the market softens.

Increase capital efficiency

Capital efficiency is a measure that shows how effectively your company uses cash by comparing how much you spend on growth to how much you receive back.

Since the cash tap has been running slower for businesses, the money leaks that previously were barely noticeable now can quickly bleed the company dry. Generating revenue is great, but it might not be enough to survive and stay competitive in this tumultuous economy without rationing your capital expenditures. Investors know this and have changed their standards in favor of strong capital efficiency indicators over outstanding growth rates.

How do you increase capital efficiency? By knowing where you stand and what areas could be improved.

Here are the four capital efficiency metrics to track:

1. BVP Efficiency Score — a simple high-level metric that looks at revenue as a return on your capital expenditures. It is calculated by dividing your net new ARR by your net burn in a given year. The best score you should be aiming for starts at 0.5x, with the best result being over 1.5x.

2. The Rule of 40 — a SaaS-specific metric used to gauge a company’s combined revenue growth rate and profit margin, calculated by adding them. As the name suggests, a healthy benchmark should equal or exceed 40%, and it gets harder to keep it at this rate as your company grows.

3. The Magic Number — a well-known metric that measures the efficiency of your sales team by calculating how much money you get for every dollar spent on sales and marketing. A magic number below 0.5 means your sales could be better and must be reevaluated to reach at least 0.75 or higher.

4. CAC Payback — a popular measure that shows how long it takes for your company to return the costs spent on acquiring new customers. The formula can vary but the most common one used in subscription-based businesses is the following: 

Average CAC per customer / (Average MRR (Monthly Recurring Revenue) X Gross Margin, %). 

The benchmark for this metric depends on the business. In the B2B sector, investors usually want to see 12 months or less, with eight months being the perfect result. B2C businesses usually recoup CAC faster, but benchmarks can vary depending on the industry.

Trim unnecessary costs

There are many cost-cutting measures businesses can take when the economy goes sour and revenue goes down. Since growth isn’t your only priority now, some of your spending becomes unnecessary and can be cut back. But it’s also important to not go overboard with cost-cutting and be strategic about it.

The following steps will help:

  • Conduct an audit of your expenditures. Either with your accountant or by yourself, analyze where your money goes each month and identify areas where you can spend less without harming your bottom line. Talk to your teams and discuss where you can pause your subscriptions to services, media or networking groups, or consider downgrading your plan. The same goes for office expenses like phone services, utilities, equipment, etc.
  • Negotiate better terms. Depending on the nature of your business, you might negotiate with your office or storage providers, suppliers or banks to decrease or at least lock in rates and stretch the payment window to pay later and keep cash around.
  • Consider layoffs carefully. It might be tempting to let go of people to preserve costs, but resort to layoffs only when it’s necessary. The cost of hiring and training personnel is lofty, and there’s a risk of firing people whose input might not be apparent but is significant. In many cases, granting a leave might be a strategically better way to cut expenses.

Focus on revenue

An economic downturn doesn’t mean you should slow down your revenue machine or abandon your growth goals altogether — simply readjust them toward bringing more immediate cash.

You can include the following:

  • Commit to customer retention. Between new and old customers, the latter always wins in terms of revenue. Hence, reducing churn and keeping or increasing retention must be your priority. Invest in quantitative and qualitative research, launch loyalty programs, implement customer feedback and provide impeccable post-sales support.
  • Revise your pricing. Over 80% of businesses we work with are looking into increasing prices or changing their pricing models to provide an immediate uplift and compensate for some lost growth. Consider shortening your free trial period, charging more for advanced features, introducing more packages with varying features and pricing, or simply increasing your prices.
  • Rethink your marketing activities. It’s been proven that businesses that keep their marketing activities up and running during a recession exit it with the highest sales records among the competition. But be sure to look for better, more efficient ways to grow your market share. Rethink your strategy, ditch channels that don’t work and double down on those that do — but don’t slow down the engine.
  • Explore new revenue streams. It can mean expanding your customer base to new markets to compensate for lost clients or adapting your product/services to industries likely to grow.

Diversify funding sources

When venture capital becomes more expensive and less accessible, the next best thing after extending your runway is to keep your funding options open. Some early-stage companies we work with are already resorting to or considering alternative ways to get funds.

They include:

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

Some options might not be ideal, but having a backup plan to access funds in this volatile market is vital.

Adapt to the shifted priorities to win

It’s clear that the markets are unlikely to upturn in the coming year. Just like with any crisis, those capable of quickly adapting to new rules will be the last ones standing. In this case, the winners will not just survive the economic whirlwinds but also tap into the riches of the dry powder stored up for those who understand and play by the new rules.

Don’t wait out the storm — it will get you nowhere. Instead, act like winners and be proactive: Stay on top of your key metrics, boost capital efficiency, be strategic and regimental with your capital, focus on what brings you revenue, and diversify your funding options. This way, you’ll retain control and set yourself up for long-term success in this volatile environment.

In the past 10 years, Igor Shaverskyi helped more than 500 startups and venture funds around the globe raise over $3 billion in funding. A big fan of everything lithium-powered, he helped with several battery and bike-sharing investments, and is now driving and exploring the world of EVs on his own. A huge believer in the enormous potential of VR, AR and the Metaverse, Shaverskyi is also a travel addict who has visited more than 100 countries and completed two round-the-world journeys.

  • Originally published March 22, 2023