As managing partner of MGV, Marc Schröder focuses on working with world-class tech entrepreneurs and establishing the MGV legacy.
Given the recent change in capital markets and the investment climate for startups, many fund investors and LPs are taking money off the table and taking a wait-and-see approach to future capital deployments. The war in Ukraine, rising interest rates, inflation, the growing likelihood of a global recession and falling stock prices mean that investors currently see more risk than reward in the world. This is a scary time to put fresh money to work!
Investors have a duty to use the capital they’ve been given wisely, and most fund managers have a pretty hard time advocating investing in just about anything at this point. It is the responsibility of the fund manager to assess the risk to which he exposes his LPs and good fund managers take this responsibility very seriously as they should. The other dynamic that balances this important consideration is that good investing is always about the long term. When times are scary, that doesn’t always mean quitting is the right move. Cost averaging is the name of the game, so when prices drop, it’s time to buy. As Warren Buffet said, “It’s much better to buy a great company at a fair price than buy an honest company at a great price.”
A shifting dynamic
Just months ago, the founders had seemingly unlimited access to cheap capital. They could dictate terms, demand high valuations and enjoy the fruits of bidding wars between investors. Those tables have now turned. Today, many founders face short runways, rising costs and limited access to capital. Investors are now trying to pressure founders over their burnout rates and valuations as the risk of deploying fresh capital has increased significantly.
Early-stage start-ups are almost always years away from profitability, so if you think the global economy will correct to its established upward trend sometime in the next 3-5 years, this is actually one of the best times to get into early- investment phase. podium startups. Investor leverage has never been higher and we are able to close deals with promising startups at massive discounts. In addition, these startups are becoming smarter and stronger due to the current climate. Burn rates are suddenly at the forefront and pathways to revenue and profitability are among the top priorities. In the days of easy money, “growth at all costs” was in vogue – the idea that you could grow a business to scale on limited revenues and then convert it to profitability once scale was reached has been around ever since. disappeared.
All great news for investors: the foundations being laid now will give rise to some of the best companies. Establishing healthy patterns and processes around controlling costs and achieving profitability is the best mindset a startup company can be born into. It gives rise to smart, realistic founders.
Founder focus
Another thing that hasn’t changed in the early stages of the venture is the most important element of our business: focus on the founder. Investing in good founders is the name of the early stage game and that will not change under any economic circumstances. Given the risks in the market right now, holding on to this part of investing will determine the winners and losers in venture capital over the next decade. Instead of chasing the hottest deals, VCs are spending more and more time focusing their risk assessments around the founder rather than who else will be on the cap table. This is great and an extremely healthy shift for our industry. The silver lining of the types of downturns we’re currently experiencing is that it’s bringing everyone – investors and founders alike – back to basics. Investors should focus on investing in great founders (rather than chasing hype) and founders should focus on building world-changing companies (rather than chasing the next massively overvalued companies). The pain of this volatility is worth the price of admission.
The biggest early-stage venture risks aren’t just about losing capital to startups that fail, it’s also about not getting a solid return on that capital. Bad VCs lose money, mediocre VCs generate flat to mediocre returns, and the big VCs that raise future capital generate amazing returns for their investors. Through this lens, the best VCs should always be thinking about how to get outrageous returns relative to their competition. Buying in big companies when valuations are falling is the best way to do it!
The market is also showing us that these dynamics tend to be most concentrated and valuable in early stage investing. The ‘Series A’ crunch is very real as companies emerge from the start-up phase and are expected to generate real revenue and gain market share. This is much easier to achieve in bull markets when growth capital is available and large companies have less margin constraints. In our current environment, companies transitioning from seed to series A find themselves between a rock and a hard place. Right now, they are forced to choose between a lower valuation to secure the capital needed to scale, while at the same time facing a shrinking capital base. From an investor’s perspective, this transition carries significantly more risk than investing in the pre-seed or seed stage of a great company that has 1 or 2 more years of work to do before they are ready to start looking according to the type of expected turnover and market share.
As we enter 2023, I suspect early-stage companies with great founders will still be able to raise the capital they need to keep building. A-series startups and beyond will keep grinding until a directional solution hits the capital markets. If you’re willing to commit capital to great founders who pay close attention to the fundamentals, you’re looking at a once-or-twice-in-a-lifetime opportunity to create generational wealth in the next five to 10 years.
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