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A year ago, startup founders often found themselves fought over by venture investors eager to grab a piece of any promising young company with fast growth potential. Investors competed in an increasingly heated environment in which they were often under pressure to close outsized deals in a matter of days. All told, venture capitalists spent a record $643 billion in 2021, almost double what they had the year before.
But times are changing. Global venture investment in the first quarter of 2022 dipped 13 percent quarter-over-quarter, marking the first time in a year of funding records when startup capital investment fell from one quarter to the next.
Rising inflation, a stalled IPO market, and ongoing instability sparked by Russia’s war in Ukraine have injected new caution into startup investing. As a result—with the next VC check suddenly not as certain as it may have been even a few months ago—investors and others in the industry say startup leaders should consider tamping down on spending and conserving cash.
Cash burn essentially refers to the rate at which a startup is spending its venture capital. The issue is especially important for venture-backed startups, especially when the fundraising environment is iffy. That’s because startups are usually not yet profitable: Any revenue they generate is typically plowed back into the business in a bid to scale as quickly as possible.
Das said he is making sure general and administrative and R&D expenses at his portfolio companies are in line with those of other companies—including those that are public—in the space. He is also making sure sales and marketing teams are hitting their quotas and creating pipelines.
“Cash is king right now,” he said. “I’m trying to tell people now is a bad time to be raising money and you should have at least 18 to 24 months of runway.”
Getting out the fire hose
Startups can extend their runway by pulling back on hiring, shedding big expenditures like real estate, and in more rare cases, laying off employees.
While we haven’t yet seen widespread bloodletting in the industry, several prominent startups have laid off employees en masse this year. The most prominent of those is mortgage startup Better.com, which has reportedly slashed its headcount from about 10,000 in December to less than 5,000 as of this month. Company leaders blamed a declining mortgage industry and said the cuts, while painful, will “further position Better on its pathway to profitability.”
Other startups with significant layoffs this year include:
- Indian edtech startup Unacademy reportedly cut about 1,000 jobs earlier this month in a bid to conserve cash.
- E-commerce startup Fast abruptly shut down and laid off its workforce of about 450 people after raising $100 million from investors. The company reportedly had annual revenue of only around $600,000.
- Cosmetics company Glossier, most recently valued at $2 billion and at one time believed to be a 2022 IPO candidate, earlier this year laid off about 80 employees, or a third of its corporate workforce.
- Home-buying startup Knock laid off nearly half its workforce and scrapped plans for an IPO, instead of raising $70 million in fresh private capital.
- Automation software firm Hyperscience laid off 100 employees, or about a quarter of its staff, last month. The company has raised nearly $290 million from venture investors.
But despite some prominent examples of cost cuts, investors we spoke with say they’re largely advising their startups to stay the course and be mindful of cash spending, while still aiming for solid growth.
This time is different
Some startups are still posting strong growth numbers despite the downturn in the VC market. Yash Patel, general partner at Telstra Ventures, said he still sees later-stage portfolio companies with sound fundamentals that are growing 2x to 3x. In those cases, he is most concerned with creating more runway for companies than cutting costs.
“I think extending a round makes sense now,” he said. “We don’t know how long this may last. … Taking a little more dilution now for cash to grow may make sense. It buys more runway.”
He sees early-stage companies as being less affected right now by the downturn, although many new founders of such startups may have to temper their expectations since the funding environment is different than last year.
While Patel said he planned to see rounds with pay-to-play provisions, he has yet to see them during the downturn. Pay-to-play rounds basically require existing investors to invest on a pro rata basis in current or future rounds or lose some of their preferential rights. Such provisions are sometimes added to down rounds to make sure previous investors pony up.
Scaling back hiring provides another way startups can conserve cash, in some cases adding only a fraction of what they had hoped to add to their workforce this year, Patel added.
Profitability also is something that may be talked about more, but thus far in conversations, it is not a demand from investors, said Patel.
“I’m not as concerned as I have been in previous cycles,” Patel said, adding the current environment is much different than that of March 2020, when many thought a Black Swan event was underway.
The main ways companies control cash burn are by managing fixed costs, said Stefano Bonini, an associate professor at Stevens Institute of Technology whose research has focused on corporate finance and venture capital.
Fixed costs will “eat your entire company funding if you’re not careful, especially in a high-interest rate environment,” he said.
Headcount growth is one of the easiest ways to manage fixed costs, Bonini said, so we’ll likely see startups pull back on hiring. When they do hire, many may opt to carefully select candidates who are more expensive but can contribute to the company long-term.
Compensation packages may also skew more toward equity rather than cash, he said.
Many startups will benefit during the current “tightening period” from the cost-cutting they did when the pandemic hit. In 2020, companies quickly pivoted to remote workplaces, reducing fixed costs for office space and travel, Bonini noted.
It’s unlikely some of those fixed costs will return to pre-pandemic levels, he added. “It brought a lot of companies’ costs down,” he said. “Renting offices in Silicon Valley or New York City is expensive.”
Fundraising in 2022
“We did wonder if we were moving too slow,” said Ahrens, CEO of the company.
However, the Y Combinator company was doing well, with money still in the bank from its seed round in late 2020 and paying customers.
“The key to fundraising is having something really smart to spend money on and we really didn’t,” he said. “We wanted to work on product-market fit and work on the business.”
Ahrens hopes that strategy pays off. He understands the current market is tough to raise funding in but hopes to lock up a round closer to the end of the year. By that time, he believes he will be able to show investors strong growth metrics, as well as product-market fit.
“I don’t have regrets,” he said.
The seven-employee company is pretty disciplined about budget and always has been, so reining in cash burn has not been necessary, Ahrens said.
“We track our numbers closely,” he said. “We’ve made a few adjustments here and there, but we are still about 90 percent based on our plan from earlier this year.”
The company is tapping more into the contractor market for both engineering and sales. Ahrens said he likes working with contractors. It allows the company to scale up certain projects that work while closing down others that don’t.
Although the company has “ample runway,” in order to hit the goals the company already has in place in 2023, the company will need to hire—and that means a Series A, Ahrens said.
“I’m feeling bullish for us,” he said. “The market is turning to self-sustaining companies and I feel that will help us.”
A new sense of caution
In Latin America, which was the fastest-growing region in the world last year for venture funding, investors are also considering how to contend with a changing economic environment. While funding levels remain historically high, the region did see a slowdown in Q1, with the pullback most pronounced at later stages.
“People are more careful about valuations,” said Wenyi Cai, founder, and CEO of Colombia-based startup backer Polymath Ventures. Investors in companies planning public offerings this year, meanwhile, have largely pushed back-projected IPOs by at least two or three quarters.
With late-stage startups likely to stay private longer and face a more challenging fundraising environment, it’s more imperative for teams to demonstrate an ability to operate and grow on a lean budget, Cai said. This shouldn’t be a problem for many Latin American unicorns, particularly those who learned to scale when venture funding to the region was much lower.
Others who raised during the boom times, however, “grew up with high overhead and not great unit economics,” Cai said. They’ll need both discipline and time to grow into their peak valuations.
Matthew Koertge, managing partner at Telstra Ventures, said his firm tries to be proactive with portfolio companies that may be in trouble. Sometimes that includes helping them make difficult decisions.
“Here the focus is on reducing cost basis, break-even cash flow, restructuring and refinancing to help them survive until the next stage,” he said. “We’re not there yet, but we have experience steering startups through difficult fundraising periods over the past 20 years, including during the dot-com bust.”
— Joanna Glasner contributed.