Fundraising in this new normal: Part I

This is cross-posted from the original article published on Forbes.

In the past few years, we’ve seen a venture market like no other. A short-term blip of capital constraints and a new normal of working remotely for startups during a global pandemic gave way to a market of fundraising excess, the likes of which we have never seen before.

Disrupting the norm, this was a time when money was cheap and multiples were high—it seemed like there was no limit to the rising valuations. In fact, according to Statista, the value of venture capital funds raised in the U.S. rose from $89.4 billion in 2020 to over $155 million in 2021.

Despite these higher and higher assessments, companies had less and less to show for product market fit or key metrics. It was a field day for raising capital, but it’s important to remember how abnormal this was.

Historically, fundraising has been one of the most challenging things about starting a business. Only the best made it out of the gauntlet to go on and thrive: It took the now-behemoth Amazon 50 investors to raise their first million. As we find ourselves creeping towards a reversion back to the mean, it’s important to remember that this isn’t necessarily a negative for the industry and is a healthy correction.

The Effect On Venture Capital

The process of raising capital is both an art and a science. Investors’ appetites for distributing capital are directly tied to public markets and M&A activity—this is the cycle and recycling of capital. How you capitalize on it and when as a founder is what separates good from great.

Whether it’s through a merger or acquisition, or investments going through an IPO, venture investors are beholden to their limited partners that invest in their fund and expect a return on capital. If they are not able to return capital back to their investors, more often than not, they won’t be able to raise additional funds. This is especially true when there are so many other alternatives out there for returns, either in the form of other VC funds or other asset classes altogether.

In markets where money is free-flowing, IPOs are easy, and public market comparables are trading 50 to 100 times multiples against EBITDA, the frothy effects flow down to the private market and venture capital. Venture capitalists were seeing what was going on in public markets and assuming that their investments would do the same and trade at 50-100 times their EBITDA or even their revenue upon exit.

This single dangerous assumption led to a valuation markup in private markets that has rarely before been seen in history. On top of all this, investors assigned a premium for being private, as private companies historically tend to trade higher than their public market counterparts.

Little due diligence was done as term sheets from lead investors were being handed out on 24-hour notice at wildly inflated multiples because they felt if they didn’t, someone else would. Follow-on investors often blindly followed the leads and trusted their diligence (or lack thereof). In hindsight, it’s abundantly clear that consequences were sure to follow.

Freefall Back To “Normal”

Post 2022, public markets started to deteriorate as the Federal Reserve began hiking rates to combat inflation that was running rampant in the free money era. With a rapid spike to over 5% from what once was nearly zero, these changes meant that investors could generate a risk-free return of over 5%.

High-growth tech companies became instantly less attractive and the valuation multiples began to tumble. Even higher-risk investments like venture capital lose their attractiveness altogether when the risk-free rate is so high—which, in turn, means venture capitalists have a harder time raising capital, translating into less capital to deploy. This triggered a chain reaction across private markets as well, making every pre-IPO company skittish about going public. Who would want to go public knowing their private market valuation would get decimated in public markets? And thus, a full-on capital freeze was in full effect.

A perfect storm of factors put venture capital in a tailspin: A frozen IPO and M&A market preventing the return of capital to investors; venture capital looking less and less attractive under increased Federal Reserve rates; investors avoiding risky investments like venture capital; and markdowns to private valuations via public market comparisons.

Global venture funding in November 2022 was down 67% from the previous year, and fell another 16% from that in November 2023. As everyone was waiting for the dust to settle, the venture capital world suffered.

So how do you as a founder navigate this new fundraising landscape? It all comes down to going back to the fundamentals: Being quick to adapt to the trends, doubling down on the “right” investors, level-setting your expectations and going back to building an intrinsically good company, with or without venture capital.