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Stingy VCs – how startups can now get money

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Stingy VCs – how startups can now get money

The investment climate has changed significantly in recent years. What influences the current investor mood, what that means for founders and what alternative financing options are available.

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After hitting a record high in 2021, venture capital funding is falling Number and total value of financing now at pre-Corona level. Sea KfW Research and the German Startup Monitor 2023 The mood among investors is clouded, reinvestments are less common and startups have to turn to alternative financing channels.

Read here what influences the current investor mood, what that means for founders and what alternative financing options there are. Â

Why is there less investment?

Venture capitalists invest on behalf of their investors and are therefore dependent on their capital. According to KfW However, investor sentiment is currently depressed. There are several reasons for this.

1. Many investors’ expectations of high returns have not been met recently.

Startup valuations have plummeted after hitting all-time highs in 2021. This means: either exits were completely suspended or negative value adjustments resulted in lower revenue than initially hoped. According to German Startup Monitor There are too few and too small exits in Germany. “Successful exits are a significant pull factor for new investments. It is precisely these events that create the financing cycle […] fire.“

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2. More investments are being made in bonds again.

According to Handelsblatt, institutional investors in particular, such as insurance companies and pension funds, are investing again because of increased interest rates increasingly in government and corporate bonds. Therefore, they reduce investments in VC funds, which are riskier.

3. Falling stock prices lead to an imbalance in investors’ portfolios.

An imbalance between liquid and illiquid assets has sometimes arisen in the portfolios of institutional investors. Illiquid assets, which also include VC investments, react with a delay to developments in the capital market. Whereas liquid assets such as stocks and bonds directly price in these effects. Falling share prices lead to the relative proportion of venture capital in an institutional investor’s portfolio being higher than required. Further venture capital investments will therefore no longer be made. This shift in value is called the denominator effect. Â

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What consequences does this have for founders?

The poor exit conditions and the depressed investor mood are having a negative impact on the fundraising environment. VC funds have to think carefully about where they can best use their capital. Would it be better as a follow-up investment in existing portfolio companies or as an initial investment in a new startup?

This is where a phenomenon called “power law” comes into play. The Power Law states that just a few investments in a VC portfolio will generate the majority of returns. In other words, most startups in a venture capitalist’s portfolio will fail, while a handful of companies will succeed and drive the performance of the entire fund. The Power Law is for This is particularly important for early-stage investors because the returns between the best and weakest performing companies are particularly different in the first few years. VC-funded companies that do not demonstrate the appropriate growth rates or the exponential scalability potential to achieve VC-like returns are therefore neglected by VC funds. They are called VC orphans, or VC orphans.

In addition, the deal flow climate has improved. According to KfW the mood regarding the amount, quality and innovativeness of the deals is positive. Startups that have financed themselves through their own funds, i.e. via bootstrapping, due to their previously moderate willingness to invest, are now looking for external capital for the first time. So potential VC orphans have to assert themselves against previously bootstrapped startups and the best-performing portfolio companies. Not an easy task.

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The competition from new commitments is becoming even stronger because the entry-level valuations according to KfW be assessed as favorable. The falling valuations also have an impact on the existing portfolio of VCs. A portfolio company that is currently facing a possible exit was acquired a few years ago at a high valuation. While the company was in an investor’s portfolio, the valuation may have decreased. This means: VCs can currently acquire startups cheaply, but would sell startups from the existing portfolio at cheaper valuations than at the time of purchase. This means that VCs are more willing to invest in new ventures.

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How do you still get fresh capital?

There are various options for founders to protect their startups from going out of business if they are neglected by VCs. We list some of them. Â

Strategic Sales (Trade Sale)Â

This involves selling the shares to an investor from the industry. Strategic buyers are established companies from the same industry that hope to gain a strategic advantage by purchasing startups. In this way, established companies acquire patents, IP, technologies and products, or enable themselves to enter the market. This means they are willing to pay a higher multiplier than financial investors. 32.5% of startups surveyed cited strategic investors as their preferred source of capital. The benefits of this exit strategy include a potentially higher valuation, synergies from combining resources, and access to new markets and customers. However, a trade sale often means that the startup’s management loses its independence. There may also be further restrictions on business operations – such as layoffs.

Corporate Venture-Capital (CVC)

In addition to the independent VCs, there are also corporate venture capital (CVC) investors. CVCs are investment arms of non-financial companies. In addition to access to capital, this financing route brings with it reputation, industry-specific know-how, cooperation opportunities and new sales channels. 39.3% of startups surveyed cited CVCs as their preferred source of capital. Similar to trade sales, CVCs hope to achieve strategic advantages through participation in startups. A risk for startups lies in the often different corporate cultures that clash with such financing and can potentially make collaboration more difficult.

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Is now the time of CVCs and strategic investors?

Growth capital

Companies that are already at a later point in their life cycle (Series B+) can be interesting purchase options for growth capital investors. Growth equity investors focus on companies with high organic growth and established business models with scaling potential. They increase the value of companies by providing capital for growth and expansion. For example, in areas such as production capacities, product development, customer acquisition, expansion of sales channels or acquisition of competitors. Founders gain access to specialist knowledge and the network of growth equity investors who specialize in this late growth phase. In contrast to strategically motivated investors, the holding period of growth equity investors is significantly shorter. Â

Acqui-Hire describes acquisition and hiring in one process. In contrast to CVC or trade sale, acqui-hire is not about strategic advantages for the buyer through the merger of the companies. With acqui-hire, established companies acquire startups primarily based on the employees they take on with the purchase. A simple way to attract numerous qualified employees. For founders, an acqui-hire can offer access to new development opportunities. For example, the financial and organizational possibilities of an established company can help you expand your own business or open up new markets. The risks include that the buyer, after completing due diligence, poaches the startup’s key employees without finalizing the transaction. It is therefore important for founders to agree on appropriate non-solicitation clauses. Another disadvantage is that the startup and its product no longer exist after the takeover. Only the employees will be taken over.

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