From Easy Money To Hard Conversations

As an early-stage startup investor, this year, 2022, has been marked by one thing: Hard Conversations.

Lots of them. Each conversation is different, but depending on the situation, they fall into one a few buckets. The hardest are with founders who are already in your portfolio. As an investor, you’ve already made a commitment to them beyond just investment dollars. Following this are new investments and relationships, as most early-stage investors seek to maintain their pace through both good and rough times. And finally, hard conversations with other investor friends in the ecosystem about what to expect.

I wanted to briefly lay out the high-level messages in these conversations. None of this will be new or revelatory for those in the startup world, but perhaps the way it’s framed here can help some folks who are sorting it all out.

First, founders and existing investors should by now realize that any additional financings, no matter how large, will need to clear a proper checkpoint — the larger the financing, the more checkpoints to clear. Founders will need to demonstrate clear enterprise value inflection points, and even if they’re achieved, investors may wait until well after those milestones are hit. In the past, founders would get credit for the belief they would hit the milestones — that speculation is no longer rampant.

Second, early-stage founders who do have capital and some runway ahead of them, they need to really preserve that capital. A mentor of mine and experienced VC/operator put it this way: A early-stage startup CEO should at least go through the thought-exercise based on the prompt, “What if we can never raise money again?’ What would one do in that scenario? How would things change? It’s rhetorical, but also now, unfortunately, a fair question to ask.

Third, founders would be wise dual-track an exit path to keep their options open. This should happen much earlier than folks are comfortable with. Potential customers, designer partners, industry collaborators, large companies — any outfit where the founders and startup have a relationship with a larger entity, those are all relationships to cultivate carefully on the off chance they could lead to a deeper partnership or acquisition. For a company reading this today that has runway into 2023/24, starting this in January with a goal of having something happen by end of year is not unreasonable. It’s very very hard, but not impossible.

For an early-stage founder, it can feel like the walls are closing in. And, they are. In previous downturns, startups could still be acquired for modest o great sums; today, these types of transactions feel frozen, and larger-cap acquisitions face regulatory, shareholder, and balance sheet scrutiny. While everyone is anchored on rising interest rates to dampen inflation, it does feel that inflation will be here to stay as a long-term phenomenon given the disruption to and rebuilding of the global supply chain. Profitable companies generating less than $100M of revenue with high margins are less likely to be able to go public, stuck in no-man’s land. Perhaps most daunting, many of the emerging platforms folks have been excited by — crypto, AR/VR or the met averse — feel very far away or, worse, unattainable. A rare bright spot is AI (more on that soon), but it is the early-innings there and the jury’s out on how those technologies monetize given the open source pressure.

I’ve been investing 10 years now. During this time, I will admit it has been hard to often feel “heard” as an investor at the table with many founders. I’ve tried to share what I’ve written above with various founders, and it is not easy for this to land properly oftentimes inside a founders’ head, which is 24/7 consumed by product, customers, colleagues, not to mention stresses that can accumulate on the personal and household side of things. It is understandable, as entrepreneurs likely should not be obsessed with the market as investors are. As investors, the tools we have at our disposal represent a sort of soft power in the best case, to persuade and guide, and to hope the messages eventually sink in with reason and empathy. That’s my sincere hope with this post.