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Raising Funds in a Changing Market: The VC Perspective on Fundraising

Earlier this year, we held our annual CEO & Co-founder Summit and I led a panel of fellow VCs in discussing the current economic climate. We talked about what the market looks like now, where we see the market going, and how entrepreneurs can navigate the current turbulent fundraising waters.

The panel included my friends and colleagues:

  • Courtney Buie Lipkin, Partner at Susa Ventures. Susa invests in Series Seed and B companies across all verticals. Courtney is particularly interested in companies changing foundational industries like real estate, transportation and logistics, insurance, and finance.
  • Eric Ver Ploeg, Founding Partner at Tunitas Ventures. Tunitas Ventures focuses on helping companies get their Series A from the best possible investor. Eric has been a venture investor for over two decades and, prior to his VC career, started two venture-backed companies.
  • Pramod Gosavi, Principal at 11.2 Capital. At 11.2 Capital, Pramod focuses on enterprise software, including SaaS, cybersecurity, developer tools & enterprise IT. Prior to 11.2 Capital, Pramod was Director, Strategy and Corporate Ventures at VMware.

Here are some of the highlights from our conversation:

Warren Packard: The macroeconomic conditions have changed significantly since April 2022. How are current conditions influencing your investment decisions? 

 

Courtney Buie Lipkin: What I’ve seen personally, is there’s a delay in the reaction of the seed market compared to what’s happening in later stage growth and in the public markets.

The seed market is still where it’s been for the past seven years, which is to say prices are pretty high when founders come in and talk to us about their fundraising expectations. And when we’re sitting on the other side of the table as investors, we’re doing the math and, and I think the markets are telling us now, it is quite rare to have a company that’s valued at a billion dollars. Maybe over the last five years, it wasn’t so rare, but it’s actually incredibly impressive and very rare to build a business that’s valued at over a billion dollars. Then when you think about the multiple rounds of fundraising and the dilution that comes along with that, from the founders’ perspective and the investors’, that entry price matters a lot for seed funds.

 

Eric Ver Ploeg: The markets are down, but the price compression we’ve seen in the public markets isn’t that bad. Relative to how awesome it was in 2021, it’s bad, but when the price to earnings ratio on the S&P 500 is sitting around 20, that’s not bad times in the market. It’s not super exuberant times, but it’s not bad times.

So, we’re seeing prices coming down from the craziness of 2021, but it’s not like they’re going to fall down precipitously. 

Anecdotally, one view on this is that at the early stage—Series A-ish companies—knew things were really hot and piled some cash on so they wouldn’t need to raise for a little bit. So, we’re still in this little period where it’s like Wile E. Coyote being chased by the Roadrunner and he doesn’t know that he doesn’t have ground under him anymore. It’s not until he looks down and sees, “I need to raise another round,” that the pricing comes down. And it’s still not going to come down that much because the public markets aren’t that bad.

 

Pramod Gosavi: We are seeing a lot of rounds getting smaller, deals are taking longer, and first time founders are struggling to raise at all. There are three ways the economy is shifting. First is that the public multiples have come down, so that is a reset of about 50% from where it used to be. The second is that founders think they are going to grow 3x year after year, but that is not happening anymore. So you have to go down from that 50% down to 35%. And then, some of the business models seed companies are using are just not going to work. Echoing what the others said, it’s going to take some time for the reset to hit the seed stage, but it is coming. 

 

Warren: Eric, you’re a specialist in getting a company their Series A. When you get involved with a venture, what makes you think this is a company that can get funded? 

 

Eric: It’s really context specific, so if it’s a straight up the middle enterprise SaaS business model with a traditional go to market motion, then it depends on how much cash you’re trying to raise and if you’re shooting for top tier VCs. To really oversimplify it, in the case of a straightforward SaaS company that has at least a couple million dollars of ARR, I’d want to see 20-ish customers using the product for the same thing. It can be pretty bad if each customer is in there for something different. You can always grow fast by throwing cash at things, but the top tier Series A firms are going to be looking for a unit economic model that makes sense. 

Now, when you’re dealing with business models that aren’t your typical enterprise SaaS, then it is incumbent on the team and their advisors to put together a model that shows that additional capital can be well deployed and will make the company more valuable.

 

Warren: Courtney, you get a two-part question, because your firm invests at the seed stage and the Series B stage: what are you looking for in companies going for their Seed round and companies going for their Series B?

 

Courtney: Yes, we do have an opportunity fund and we use that mostly to invest in our own portfolio companies that we know very well, but occasionally we do invest in new companies at that level.

The main thing everyone is talking about since April last year is burn multiple, which is the efficiency of bringing on revenue versus how much you’re burning. Many of the venture-backed businesses over the last decade have been burning a ton of capital to grow quickly and now it’s a different narrative than what we’ve been working with over the past ten years. 

While the exact number of your burn multiple is going to depend on your business, you will need a very clear path to profitability when you are a public company and be EBITDA profitable. This has never been a conversation at the B or C before. Profitability isn’t a requirement for B or C, but it’s a conversation about where the leadership team is looking ahead towards a world where the business can be a self-sustaining public business or an attractive acquisition target for a major public competitor. 

 

Warren: There are a number of heuristics that investors and executives have used to guide themselves and measure if they are on track—such as the Rule of 40, and the Triple, Triple, Double, Double, Double—are these pre-April ‘22 relics? Or do they still apply?  

 

Eric: I’m a huge believer in the Rule of 40, especially when you’re looking at top line revenue growth and adding in the measure of EBITDA divided by revenue. That’s usually a negative number in the companies we’re looking at. The two together early on at the seed stage is not that meaningful, because one might be a gigantic 300% and the other is minus 200%. As you get more established and one of them is, say, 62% and the other is -10, then that starts to look really attractive for an enterprise SaaS business model because you can always give up some growth if you need more profitability. Or vice versa, I can deploy more cash and it may not be as efficient, but the top line is really great. 

I think Triple, Triple, Double, Double, Double is more a measure of how fast an enterprise SaaS company can grow when it’s growing as fast as it can without completely coming off the rails.

 

Warren: Let’s turn to the question of Artificial Intelligence—this is after all, a gathering of the AI Fund. What are your thoughts or your firm’s thoughts on AI? What sectors are you looking at? 

 

Courtney: We are a generalist fund and we don’t really think about AI as its own vertical, but rather its application across different verticals, such as fintech, logistics, healthcare, and enterprise SaaS more broadly. For example, logistics has a lot of repetitive, highly manual workflows that are great applications for AI. Insurance is another example where we’re thinking about applications that can help with underwriting and risk mitigation. 

I’m excited about the things that are possible, but I have a huge caution. I see way too many companies say, “I’m an AI company,”  and that’s the first thing they say. To me, that’s almost a categorical pass. Successful tech-push companies happen occasionally, but generally there’s a customer problem or market need that the tech can address. AI now enables us to solve a category of problems that weren’t solvable before and it creates categories we can’t even preconceive yet. I’m looking for companies that are creating new categories. 

 

Pramod: When we look at AI, it’s mainly applied AI and that requires customizing the models. The thing that I want to stress is customizing the models. A lot of founders don’t get this customization and getting that last mile, which requires a strong data strategy. 

We like to see a level of sophistication with the founder on just how they are going to get data to train the model and leverage that model across all the customers. If you have to rebuild the model for each customer, that’s not a scalable business.

Warren: Let’s shift gears here and talk about board dynamics. I think there is a certain point of view that board meetings are not a good use of time—that venture capitalists just descend into a company periodically, say a few things and then leave. What is the best way for a company to maximize the value of its board of directors? 

 

Courtney: I’ll caveat this by saying at Susa Ventures, we usually take board observer seats because we lead seed rounds. 

I think that early stage investors, even investors that have been operators before, are most useful for fundraising at the end of the day. That’s the only thing that venture capitalists will really, by definition, know better than the operators they are working with. The operators understand their technology. They’re working with customers day-to-day. There isn’t a ton of value that an investor who’s sitting at their desk every day can add by dropping in for 90 minutes and talking about the technology or the company’s customers. 

But the thing that we’re always going to know more about is fundraising. We’re talking to other investors every day and the information does change week to week in terms of where pricing is, who has appetite, who just closed a new fund, and who’s out of the market. 

So, the best use of a board meeting is to keep your board up to speed and to help them help you think about the metrics that are important—your burn multiple, Rule of 40, and so on—so they are calibrated for your next round. 

If you’ve raised a seed round, then you’re on this path of being a venture-backed business. Before that, you’re bootstrapped and you can be any kind of business you want. But once you enter the venture market, then you’re on this treadmill of every two-ish years raising the next round and having expectations from your VCs and their LPs about what type of asset class you are (versus bonds or public market). So your VCs are going to look for a certain growth rate and a certain exit.

 

Eric: I raised five rounds of venture across the two companies I started, and I’ve been on 26 venture-backed boards in 11 years, and I 100% concur. The entrepreneur who’s working the business 80 hours a week knows a lot more than the venture people who fly in for an hour a week. The one place where that information asymmetry flips the other way is around fundraising. The typical entrepreneur raises a Series A, one, two, maybe three times in their life. Whereas VCs are constantly having those conversations. A good VC doesn’t have an order of magnitude more knowledge on fundraising, it’s more like three orders of magnitude more. That’s really the whole genesis and focus of my fund is to help entrepreneurs raise their Series A.

In addition to fundraising, the one place board members can really help is asking the “forest for the trees” kinds of questions and helping you think about the business in ways that you are too busy chopping trees down to see.

 

Pramod: We do take board seats and in addition to the fundraising counsel, we think of ourselves as more of a coordinator, looking at the team and finding what’s missing. If the team needs marketing help or product guidance, we can bring in an operator who can coach them. 

The other thing that we do is help keep companies disciplined by having monthly board meetings, and making sure they’re making progress on all of the important KPIs. The board meeting tends to be like a snapshot to help the founder see where they’re making progress and where they’re not.

 

Warren: In your capacity as seed investors, what constitutes a good exit for you as a multiple of your investment? And what’s a great multiple of your check as an exit?

 

Courtney: Every time we make an investment, we are thinking, can this return the fund? With a $120 million dollar fund, we may put in a million or million and a half. We are recalibrating around the fact that it is so hard to build a business that’s worth a billion dollars—not like if you squint and it looks like a billion dollars, but really worth a billion. And at that point, will we own 10% of that business? That’s what we are thinking about and hopefully there will be one or two in each fund.

 

Eric: I have a slightly different way of approaching the thought there. If you look back at the last 15 years of venture and the top 10 exits in each of the years, not the top 10%, the top 10 on a simple count basis, they’re a third to even 60% of all the profit generated in all of venture capital. 

So, I’m thinking, is this company a company that is creating a brand new category that is big enough to move the needle and a business model that is defensible? Copycats always come and when they do, are you still able to build a real business? I want to be in the companies that have a chance of being one of those top 10 each year. 

 

Pramod: Everyone is trying to return the fund, but how much that is depends on the size of the fund. You can have a seed fund of $20-30 million and be OK with a 10x or 20x exit, but if you take from a large fund, they’re looking for that billion dollar exit.