Startup funding dry spell may be ending, but uncertainty remains

Several months after just about every venture firm told their portfolio companies to prepare for a funding drought, some investors are saying the health of the startup ecosystem may not be as dire as it once seemed.

“Deals where we would consider leading a Series C or D—that was dead six months ago. That’s starting to pick up again,” said Mitchell Green, founding partner of growth equity firm Lead Edge.

Investors are expressing renewed, albeit cautious, optimism thanks to strength in some tech earnings, particularly of cloud companies, which has helped stabilize public markets recently. Other positive factors include a sense that inflation may have peaked, receding fears of a deep recession and VC’s record levels of dry powder.

“There’s a feeling that stocks hit bottom in June,” said Greg Martin, managing director at Rainmaker Securities, a brokerage specializing in sales of stakes in late-stage technology companies. After many months of tepid secondaries activity, trading has jump-started over the last two weeks.

The stock markets’ decline on Friday after Federal Reserve chairman Jerome Powell’s comments about the central bank’s war on inflation shows investors remain uncertain about the direction of the economy and highlights the fragility of the current rebound in dealmaking.

But in the meantime, startups are gradually accepting that valuations have declined from their 2021 highs.
 

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Last year, every company was hoping to go public at “crazy” multiples, said Morad Elhafed, a general partner with Battery Ventures’ growth buyout strategy, which takes majority positions in software companies growing around 30% annually. “We can now strike deals [at valuations] that were not available a year ago.”

While multiple investors said they are starting to see deals done at pre-pandemic valuations, companies’ pricing expectations have not yet fully caught up with the lower levels.

A great percentage of startups have sufficient cash runway not to have to worry about raising in the next 12 months anyway. It may seem like venture capitalists took the summer off to vacation in Europe or the Hamptons, but it looks like they found time to help portfolio companies that were short on capital shore up their balance sheets.

Cutting extraneous costs has helped, but it’s venture debt—a strategy that’s seeing new significant entrants—that ultimately saved the day for startups that had less than a year of operating cash, said Yash Patel, general partner at Telstra Ventures. Of the firm’s 80 portfolio companies, 72 now have around 18 months of runway, and the remaining eight startups have not yet run out of cash-infusing options.

Six months ago, Telstra’s portfolio didn’t look as healthy, and Patel was worried. The firm even considered running distressed M&A processes, but such acute measures turned out to be unnecessary.  

Other venture firms are also saying that the majority of their investments are similarly well-capitalized.

The storm clouds have not fully receded over venture capital land yet—there is still a devastating war in Ukraine, inflation to be tamed, and a recession to be avoided. But despite this uncertainty, we are unlikely to see a big wave of down rounds this fall. 

That’s not to say that some unicorns won’t have their horns chopped off, but startups seem to be in relatively good shape at this point in the cycle.

Featured image by Jonathan Kitchen/Getty Images