Against a backdrop of weaker sentiments and a capital downturn in 2022 and 2023, large venture capital players and accelerators like Sequoia Capital and Y Combinator have sounded the alarm bells, warning their portfolio companies to “plan for the worst” and that “the market is signalling a strong preference for companies who can generate cash today”.
The numbers bear it out. According to Crunchbase, venture funding in Asia declined to $36.3 billion in Q1 2022, down 31% from the previous quarter. Deals followed suit, with only 1,709 deals announced in Q1 2022, a 21% quarterly drop from 2,153 deals closed.
The silver lining? A majority of active startups in today’s landscape already went through the COVID-19 funding winter in 2020. VCs and institutional investors like myself have lived through the 2000 dot-com bust and the 2008 subprime mortgage crisis.
Go through these cold seasons enough times, and you’ll find certain strategies may raise your startup’s survival odds.
Beware the enthusiastic, uninformed investor
When a new investor unfamiliar with your startup’s sector or market suddenly throws out a term sheet and agrees to your highest valuation, watch out – this is often a sign that the market has peaked.
First, be wary that this new investor may not fully understand your space, so potential conflicts can easily arise down the road. Second, with a high valuation, you’ll soon be expected to justify it with untenably high growth figures.
Take, for example, Chinese fresh food delivery startup Missfresh (Ticker: MF), which found itself struggling to survive barely a year after its Nasdaq listing. The company had over-expanded into cities where the lower average order values meant that the unit economics did not work. As their cash reserves dwindled and investors could not see a pathway to profitability, their valuation dropped from $2 billion pre-IPO to a mere $25 million.
The point is that your investors may push for capex-heavy growth investments that drive user numbers, but may not necessarily bring in cash or a profit. If you’re not careful, this could set your company up for trouble, whether you choose to scale quickly through subsidies, over-expand into new markets or lines of business, over-hire or in some extreme cases, resort to fraud.
Watch out for deal-making red flags
So an investor offers to double or triple the term sheet you have in hand but demands exponential growth of 5x to 10x. If you aim for 5x growth, can your organisation scale as easily? For operationally intensive businesses, this can lead to unrealistic expectations.
Another one is usually when investors throw unit economics out of the window and don’t care if you lose money on every order you have. Shortly down the line, it will be very difficult to pivot from being a growth-at-all-costs (hunter) company to one with rational growth and good unit economics (farmer). The switch from a hunter to farmer mentality requires a culture change that can derail an organisation.
Beware, too, the strategic investor who offers a higher valuation so long as you adhere to their corporate objectives, such as not doing business with their parent company’s competitors. Always ensure that your investors understand your business and are aligned with you on the overall strategy.
For VCs, standing on the sidelines is not an option
When the dot-com bubble burst, everyone was too scared to invest.
I was fortunate to be on a team that went on to invest in Alibaba, whose strong corporate culture helped it survive the 2003 SARS epidemic. We also didn’t give up on Tudou, the “YouTube of China”, bringing more investors into the next funding round, which eventually led to its IPO completion.
If you invested too little to limit your exposure, your startups may die from a lack of funding. We reminded ourselves that we are mandated to put money to work, and we can find good opportunities in bad times.
Investors need to realign their expectations to match the state of the market. Influence your founders positively; take calculated risks, reexamine the fundamentals, and help them better manage cash flow.
Try not to become ‘momentum’ investors by succumbing to FOMO. Always make decisions based on a company’s fundamentals and hold founders accountable with tough love.
The more perspectives, the better
Whether it’s a global pandemic or a prolonged weak fundraising environment, someone somewhere out there has weathered it before. Do not be afraid to seek out coaches and mentors to guide your decision-making.
Track your cash flow and cash in the bank after payables are taken into account, and assume you cannot collect on your receivables. Are there any payables that you still need to sort out? If you have an adequate cash runway (18-24 months), start strategising for how you can pull ahead of your cash-strapped competitors.
If you need to fundraise, can you get the round done quickly? Too often, founders have unrealistic assumptions about their fundraising, resulting in long, drawn-out processes that drain resources.
If you need to fundraise and you cannot get the round done, can your existing investors support you? Do not hastily dismiss lower valuations, and consider relinquishing some rights to sweeten the deal – this is a play for the long run, so your reputation is key.
When in doubt, go back to fundamentals
When it seems everyone’s afraid, remain calm and return to the fundamentals: Are users still using your service? Do they like using it? Are they coming back? Is your user base growing?
Remember, markets are not static – if your competitors take the opportunity to grow while you are paralysed by fear, you’ll spiral downward. Founders need to assess their competitive positions and cash runway before deciding their next steps.
Many founders here have not been tested by the capital intensity and competitive ferocity of developed markets such as China, which can be a brutal environment to compete in.
The competition will intensify in Southeast Asia as more capital and talent flow into this region, so be prepared for what’s to come after this current funding winter.
The author is a managing partner at AC Ventures, an early-stage, Indonesia-focused venture capital fund.