It’s safe to say that the rules of the fundraising game in 2023 are different than they were a year ago:
- Down rounds are becoming the norm as tech valuations keep tumbling.
- Venture funding and deal volume continue to fall.
- Venture debt is less accessible to startups.
- The time it takes to raise a round has increased by ~30%.
The situation in the market has changed VCs’ priorities for early-stage startup funding and the criteria they use to assess their opportunities. Investors now are far more measured and risk-averse, preferring balanced and sustainable growth to the wasteful explosive growth typical of the past decade.
What does this mean in practice?
No matter how much potential your idea and market demonstrate, your fundamentals can’t be in a bad way if you want to raise venture capital in 2023; most VCs simply won’t take this risk. To raise both late- and early-stage VC funds in the current market, you are expected to defend your claims, show specific numbers, and, if they’re soggy, offer a solution.
If you’re a post-revenue startup looking for early-stage capital, read on to learn what it takes to raise venture capital in this volatile environment. We’ll discuss the metrics to prepare, how to demonstrate and defend them, and other tips that will 10x your chances to raise a round.
Investor expectations in 2023 & how to meet them
Generally speaking, investors want to see that your offering is generating (or is on its way to generating) customer demand and that your chosen path to profitability is working (or that you know how to make it work) – all while burning as little cash as possible.
That last point is vital. Our anecdotal evidence attests that investors now pay specific attention to your profitability and capital efficiency metrics. Can you achieve more with less? For post-revenue startups seeking early-stage financing, that’s the key question.
Before we get to the meat of the matter, there’s one thing to remember: no matter what, be honest about your situation. Investors are way more rigorous with their due diligence than they used to be and will notice any discrepancies between your words and the real situation.
So, if you are raising venture capital and some numbers are lower than you’d prefer, talk about that. But don’t stop there; explain why and show how you can get these numbers out of the dumps. The key here is to show investors that you understand the full gravity of the situation, own it, know its origins, and have a plan to fix it.
With this in mind, here are the main aspects to focus on when presenting your results and future strategies.
Show your growth
While the idea of growth at all costs has fallen from grace for most VCs, they still expect you to show positive traction. Growth is the primary indicator of your product’s potential and, as such, is the central element in your traction metrics.
Here are the main indicators of growth you should include:
- Number of new users (for SaaS companies)
- Revenue: ARR and MRR
- Value of your pipeline
If all the numbers are in tip-top shape, you will surely be challenged to elaborate on how they were achieved.
What should you do if your growth metrics aren’t great?
If, for example, your user base isn’t growing as fast as it should, but your retention rates are great, then it likely has to do with your sales and marketing efficiency. Prepare yourself for questions about your sales and marketing KPIs, problems, and potential solutions.
Or it can be that your user growth is high, but the revenue is below the industry benchmarks. The reason for this could be as trivial as pricing issues or an imbalance between the revenue you get from your old and new users. The latter means one of two things: problems with your product or problems with your customer acquisition engine.
Regardless of the monetization issues you may have, you need to prepare a good strategy to fix them before you pitch to investors.
Demonstrate user retention
All seasoned founders, marketers, and investors know that, in many ways, retention beats acquisition. The reason for this is that high retention is a strong sign of product-market fit, which is hard to find and way too easy to lose as you scale.
To understand retention, businesses often measure gross and net retention indicators for both their user retention (e.g., logo retention) and revenue retention.
For B2B SaaS, investors expect the retention rate to reach >90% for gross and >100% for net indicators. For B2C, net retention rate should ideally reach >80% but can be less depending on the vertical, so check with your industry benchmarks.
What to do if your retention isn’t hitting benchmarks?
Make sure to demonstrate your well-performing areas that compensate for that. Do you have a regular influx of new users flowing in that makes up for the revenue loss? Or do users perhaps make multiple transactions before churning?
For this situation, every B2B SaaS should have a business-specific leading indicator of retention, signaling that users value the product. While lagging indicators like retention are general and retrospective, leading indicators are unique to your customer journey and immediately show results.
Here are some examples of leading retention indicators:
- Number of transactions per user
- Number of features used
- Number of messages sent / files saved, etc.
Decide which metrics best represent your product’s success among users and, if they’re strong, put them forward.
Prove that you’re capital efficient
In 2023, if there are two companies with similar market potential and traction, investors will back the one that burns less money. Here’s another quote from Masha Butcher, founder and GP of Day One Ventures, that illustrates the moods dominating the VC space:
The most common mistake we see founders make when they measure and present their capital efficiency is using LTV:CAC as their only pointer. Since LTV:CAC is a lagging indicator, many companies tend to misinterpret it, which can often lead to inflated, “fake-positive” numbers.
Investors quickly pick up on this by looking into other areas, specifically:
- CAC payback
The CAC payback metric helps businesses and investors measure the time it takes to recoup the costs spent on customer acquisition.
If your payback time is far below industry benchmarks, this reveals that your current sales and marketing functions will require a serious overhaul.
What can you do if your CAC payback is in bad shape? The answer will depend on the severity of your situation.
If you’re slightly below the benchmarks but plan to improve your CAC payback, investors will likely agree to meet you halfway. However, if your payback time is too gloomy, you’ll likely be told to return once you fix it.
- Rule of 40
This is the metric investors use to evaluate the financial health of a software company by combining its EBITDA margin and revenue growth rate. According to the 2022 SaaS benchmark report from OpenView Partners, this metric has also become the biggest factor determining how SaaS companies are valued by investors.
An outcome below 40% means your company struggles to generate sufficient returns on the money it spends. This usually means that you must cut spending, increase revenue, or both to improve your position in the eyes of investors.
In our experience, however, cutting costs is almost always the surest way to quickly boost your EBITDA margin and improve your Rule of 40 situation. Zoom, for example, had the Rule of 40 at only 5%, which might explain why it has recently cut 15% of its workforce.
What if your Rule of 40 is below 40%, but your CAC payback is in great condition? This happens when your sales and marketing functions perform well but other money drains affect your profitability. If that’s the case, you should investigate where your money goes and plug the holes ASAP.
Ultimately, your actions will depend on how far outside of investor expectations your numbers fall. To attract early-stage startup funding, you might need to resort to cost-trimming activities or make changes in your sales strategy that will make you more attractive to investors. You can also go for it and pitch anyway if you feel like your numbers seem redeemable.
For more information on these and other important metrics, check our article on capital efficiency.
Remember to always examine and present your numbers together to get a complete and reliable picture of your capital efficiency.
8 tips to 10x your chances to raise VC in 2023
Having helped over 500 startups get funded, we have developed some well-tested tips on how to raise venture capital:
- Act early. To raise early-stage venture capital, it’s paramount not to wait until you have a perfect product/metrics to start approaching investors – just get your foot in the door. While preparation is indeed key, you can’t prepare for everything and risk losing momentum by trying to do so. Plus, the earlier you start pitching, the sooner you’ll get valuable feedback on what can be improved.
- Don’t exaggerate. Big words might’ve worked well a few years ago, but they will only annoy investors now. Being realistic in one’s assessments, on the other hand, is in full vogue – even if it means that your projections are a bit less ecstatic.
- Be honest about underperforming areas. Just make sure to also explain how you plan to improve them. Investors will discover them during DD anyway and may doubt your business acumen or honesty if you haven’t brought them up beforehand.
- Avoid the most common pitch deck mistakes. The most problematic mistakes include the failure to find a good answer to the Why now? question, unsustainable business models, lack of traction signals and external validation, and unaddressed competition or weak competitive moat.
- Apply the CCC rule (compelling, coherent, and concise) when crafting your fundraising story. Your slides must tell a story that is investor-attractive, tight, and laid out in clear, logically connected slides. This ensures that investors can understand all the key information by skimming through your presentation. The more organized your information is, the easier it is for investors to say yes.
- Make sure your financial model makes sense. Not in a “perfectly accurate” way – everyone knows the numbers will be flawed – but in a “be ready to explain how you arrived at them” way. Is your funding ask based on real numbers or pulled out of a hat? Does your profitability prognosis make sense compared to industry benchmarks? Did you include operational metrics? Is the model clear and simple? These are the key questions you’ll need to answer.
- Use pitch deck design cheats to frame your content in a way that appeals to VCs. It’s not about making your slides look pretty (although that definitely helps) but rather about how to structure, highlight, and present each data point in a way that works in your favor.
- Have an elevator pitch ready. Now, we’re not saying you should start pitching in elevators, although you can. But having a brief pitch at the ready will increase your chances of attracting early-stage funding and prepare you for unexpected situations. This way, you’ll be ready to pitch to an investor here and now, if needed.
If you don’t know where to start and need some expert help with your venture capital startup funding, give a shout to our geniuses at Waveup. Our advice and investment materials have helped startups raise over $2B, and we’d be happy for you to join the club!
How does a recession impact fundraising?
Fundraising during a recession/downturn is affected in a few key ways:
1. Generally lower valuations and smaller rounds.
2. Longer breaks between rounds due to more rigorous DD.
3. VCs tend to reserve more capital for their existing portfolio companies.
Are there any alternative funding options for startups during a recession?
Yes, indeed there are. To improve your chances of surviving the “investor winter,” we recommend keeping your eggs in different baskets and considering the following:
1. Venture debt (although this option is becoming less available after the Silicon Valley Bank collapse).
2. Bridge financing.
4. M&A/strategic partnerships.
What are VCs looking for in 2023?
The following preferences seem to be dominating the VC space in 2023:
1. The startup’s ability to achieve more with less through, for example, viral marketing and inventive business models that promise early profits.
2. Strong financial health and capital efficiency; the ability to cut costs without hurting the top line.
3. Realism and honesty. The rest comes down to each investor’s preferences in the contexts of specific industries, verticals, risk tolerance, and personal inclinations.