Entering into a New Year is a time for reflection and is generally associated with optimism, with many of us identifying key goals and ambitions for the year ahead. For startups, it’s no different. A new year is a new opportunity to chase entrepreneurial dreams and leave a lasting impact.
Over the course of 2022, Europe’s startup ecosystem had some challenges to contend with. The energy crisis, war, inflation and climate concerns stand out – just to name a few. It has meant that we’ve entered 2023 with a degree of market uncertainty and economic anxiety looming over founders, entrepreneurs and investors alike.
Some have gone as far as to say that 2022 was the ‘year the party ended’ – a dose of reality for startup founders and a moment for entrepreneurs to pull their socks off and show what they’re made off.
As a result, there’s a general feeling that investors will be more hesitant this year, that collaborations and exits might become the key goal, and that the funding totals will take a dip and valuations drop. We talked to Miguel Fernandez Larrea, co-founder and CEO of Capchase to find out how the VC market will evolve over the next few months.
The key predictions:
More scrutiny and changing metrics
“Given the current macro environment, I expect VC funding to continue to be limited in 2023. However, strong companies will continue to receive funding. Unit economics matter now more than ever. In this uncertain economic environment, investors want to know that company growth is fueled in a healthy way.”
“2022 was the year in which profitability eclipsed growth as the primary set of metrics investors care about and I expect this to continue in 2023. Tight VC capital markets mean that the urgency for profitability and alternative capital sources are more important than ever.”
More debt and alternative financing on the table
“Debt and alternative financing is increasingly being used by early-stage companies as part of their capital stack. This growth in alternative debt and funding is likely to surge in 2023. Founders of well-run, profitable startups are going to increasingly make use of these funding routes because the fall in valuations will make VC funding a much less attractive route due to how much equity they will need to give up to secure a significant amount of capital.”
More diverse funding sources
“Startups are also realizing that different sources of funds should be used for different purposes For example, longer-term capital – such as equity and long-term debt – is now being used more often for bets and initiatives with uncertain returns. This includes new product development, R&D and entering new markets. On the other hand, non-dilutive capital is better placed to be used for anything that’s predictable, like CAC, user activation, and working capital. We are also seeing increased use of purpose-specific financing solutions. These are smaller injections of capital to solve an immediate problem or exploit a short-term opportunity such as client conversion, reducing friction or shortening a sales cycle. Business-focused ‘buy now, pay later’ are one of the most popular examples of this approach.”
How should startups approach a downturn?
“The economic environment is going to be quite challenging, but it’s important to remember that the downturn is not going to be felt evenly across the tech sector. Consumer, tech-enabled fintech and overheated verticals such as instant delivery are having a much tougher time. Whereas, more pure tech suppliers working within B2B, are actually well-placed to ride out the recession. As such, startups need to be much more aware of their own unique situation rather than taking the view that they must immediately make layoffs and slash expansion plans. In fact, our own research into SaaS companies has shown that those that resisted the temptation to make layoffs earlier in the year are now generally in a much stronger position than their competitors.”
“It’s important to be frugal when it comes to budgeting and focus on preserving the runway. The best way to do this is to construct a spending plan around ‘must-haves’, ‘nice-to-haves’ and ‘luxuries’. It’s very important to be flexible. Recessions are unpredictable and a startup’s financial situation can quickly change for better or worse. Having a very strong grip on core business metrics and your liquidity situation is absolutely essential. That way you can see early signs whether the situation is deteriorating or improving and adjust your spending plans accordingly.”
Plan long term
“Plan for reasonable efficiency improvements through a structured approach around new customer acquisition and existing customer lifecycle management. It’s important to balance top-down objectives of where your startup needs to be in terms of the broader market and runway preservation, with the bottom-up plans of department heads.”
“A common course of action can be to cut sales and marketing departments. This is often counterproductive because it can severely impact medium-term growth. It may actually be more effective to increase investment in sales and marketing to capture market share as your competitors retreat. Our own research indicates that many startups are considering that course of action.”