By all accounts, the current market isn’t great for founders. Higher interest rates and inflation have stalled growth, driven up the cost of capital and turned potential funders into fence-sitters. After a dismal Q2 2023 that saw venture capital investment drop from $44.4 billion to $29.4 billion (a 34% decline), industry experts are debating what’s next for venture-backed fundraising. Is there further to fall, or have we seen rock bottom?
There are a lot of predictions floating around this time of year, but one thing is certain for companies looking for funding: By focusing on profitability and fortifying their business, founders will control their own destiny regardless of what market may come. And there are already signs that the exit environment is starting to thaw after a chilly few years, including new “green shoots” such as the $28 billion acquisition of the cybersecurity company Splunk by Cisco.
There are no ‘cheat codes’ to success.
There are still plenty of strong private equity firms with deep pools of capital to invest, but the days of going from $0 to $1 billion overnight are over. Instead, the types of companies that are getting funded nowadays tend to be self-sustaining, with proven business models and some sort of existing relationship with the buyer that provides a strong track record of performance. Modern investors are cautious, data-driven and meticulous. Their ideal company is one that can generate a profit without burning too much money in the process. Get right-sized, get profitable, get funding—it’s really not any more scientific than that.
A lot of founders want to compress time and get to the exit ASAP, but sometimes they need to let the market happen as it happens. There are no “cheat codes” to success. In the past four to five years, companies could seek funding while they tinkered with flawed business models, but investors today want provability.
Instead of bringing on a bunch of overhead costs in pursuit of potential growth, founders need to focus on the fundamentals of running a solid business right now. If they do, the opportunity will likely be there. According to JPMorgan, PE investors “sit on nearly USD 1 trillion in dry powder” to capitalize on any adjustment in valuations, pointing out that “some of the best returns have been associated with funds that were raised in more challenging economic and capital market environments.”
Here are three ways founders can create more sustainable businesses and attract more investor interest in 2024:
1. Reduce risk and highlight the founder-market fit.
Most founders have a certain tolerance for risk. Bureau of Labor Statistics data shows that approximately 20% of new businesses fail during the first two years, 45% during the first five years and 65% during the first 10 years. Maintaining confidence in the face of that risk can be a big asset, but investors are much more discerning about the level of risk they’re willing to take on.
For example, if a founder raises money because they need to, that’s a high-level risk that might signal an underlying flaw in the business model. But if a founder raises money to support a solid incremental ROI, that shows smart risk. It comes down to capital efficiency. Meaning, it’s not just about being conservative or aggressive, it’s about being honest about whether your business model truly works and only leaning in for more when it does.
Another tactic that helps reduce perceived risk from investors is developing something called the founder-market fit, when a founder’s skills, experience and personal qualities align with what the market needs. This narrative is important to establish (and drive home in pitch decks) because it highlights the resilience of leadership during unpredictable market environments—like we’re currently in.
2. Diversify key indicators to prove market value.
The market dynamic has changed over the past few years, and growth rates are not comparable to where they once were. So, why are we still measuring ourselves based on those numbers?
The mentality used to be “grow, grow, grow!” and anything less than 75% growth was seen as sluggish. But we’re in a different environment now, and founders should reevaluate their KPIs to measure their success and govern their decision making.
For example, are they winning more deals than before? Are they stealing market share from competitors? Remember, PE firms usually have long-term views (five to seven years or longer when compared to public markets), and they are looking for companies with the ability to balance short-term goals over the long term. The more context that founders can add to their success metrics, the better positioned they’ll be to explain their market value over time.
3. Experiment with pricing, but don’t devalue your product.
The startup world is hyper-competitive, and it can be tempting for founders to lower prices to boost sales. On one level, it makes sense: Reduce prices, and customers think they are getting a deal. But unlike the retail industry that is set up for this type of fluctuation, business-to-business companies that lower the price of their products just to be competitive face a losing proposition. In the long run, it devalues their products and becomes impossible to regain the original price points.
PE firms like to invest in market leaders, not companies in a race-to-the-bottom industry. Founders should think carefully about pricing and consider offering customers the ability to get in the door with less expensive products and then grow over time. This way they will still gain new relationships without sacrificing the quality of their premier offerings.
While some will view this past year as an anomaly, it might just be the new normal. It’s important that founders don’t panic and start doing unnatural things to increase their valuation. If they focus on maintaining capital efficiency and building a good business, the market will ultimately decide what it’s worth. Founders just need to work on recalibrating their expectations. Don’t hold out hope for 25x annual recurring revenue returning any time soon, and instead concentrate on building steady, sustainable growth.
Sean Cantwell is a managing partner and member of the founding team at Volition Capital. He focuses primarily on companies in the Software and Tech-Enabled Services sectors.