The blueprint for raising capital in a challenging VC market

In a challenging economic market, securing funding for startups becomes tougher as investors become more risk-averse. During uncertain times, venture capitalists may prioritize existing portfolio companies over seeking new opportunities. To attract attention in such a downturn, early-stage startups need to adapt their strategies, focusing on key metrics that demonstrate market opportunity, early traction, and growth potential.

Despite the current economic challenges, deals are still happening, particularly at the early stages of startups. The ability to raise capital in a down market depends on clearly identifying proof points that convince investors of the viability of the problem-solution equation. Founders must strategically approach fundraising, incorporating metrics into their pitch decks to showcase long-term viability and profitability.

“Timing the market is out of your control, but doing the hard work of clearly identifying the proof points that give you and others the conviction that the problem-solution equation works, and then prioritizing your resources effectively — that’s within your control,” Ally Tumasova, a venture partner at XRC Ventures, said. “The reality is, you can never time the market over the long run. So as a founder, your objective should always be to define milestones that unequivocally prove you’ve found product-market fit.”

In a tight market, specific metrics play a crucial role:

1. Burn Rate and Runway:
   • Burn Rate: The rate at which cash reserves are depleting. It includes net and gross burn rates. The gross burn rate indicates monthly cash outflows, while the net burn rate considers the difference between total spending and total revenue.
   • Runway: The estimated time before running out of cash, calculated by dividing available capital by the net burn rate. This metric highlights business efficiency, fundraising timeline, and capital needs.

Investors use these metrics to gauge a startup’s efficiency, ideal fundraising timeline, and capital requirements. Understanding and effectively communicating burn rate and runway demonstrate the company’s ability to manage expenses, plan for sustainable investments, and maintain a healthy financial position.

Total Addressable Market (TAM): Understanding and calculating the Total Addressable Market (TAM) is crucial for early-stage startups. TAM represents the maximum market demand for a product or service, indicating the potential market opportunity and product-market fit. It helps startups grasp the scale and urgency of the problem they are addressing, gauging the likelihood of target customers adopting and paying for the solution.

Several approaches can be used to assess TAM:

• Top-down approach: Utilizes existing data from reliable sources (e.g., government census) for a quick estimate, but may lack accuracy.
• Bottom-up approach: Relies on unit economics, considering previous sales, pricing data, and industry data for a more realistic calculation.
• Value theory approach: Estimates TAM based on the perceived value users derive from the product or service, involving assumptions about customer behavior.

Customer Acquisition and Customer Acquisition Cost (CAC): Venture capitalists emphasize healthy user acquisition metrics when evaluating startups. Consistent addition and retention of users, along with a paying customer base, demonstrate traction, growth potential, and value to users.

Key metrics include:

• Customer Acquisition Cost (CAC): The average cost of acquiring a customer, encompassing expenses related to advertising, sales, marketing, and onboarding.

Increasing CAC is natural as a company grows, but constant increases may signal ineffective marketing and sales strategies. A rising CAC alongside increasing Customer Lifetime Value (LTV) justifies costs. The ideal LTV/CAC ratio for high-growth early-stage companies is generally 3:1, indicating three times revenue compared to acquisition costs.

Financial Projections: Investors seek a robust financial model showcasing flexibility in capital management. Projections involve creating future financial statements, relying on assumptions and educated guesses. Investors focus on understanding the rationale behind projections, including how current numbers and growth models support estimates.

Consider two expense categories in projections:

• Fixed Costs: Independent of business or sales volume (e.g., payroll, office space).
• Variable Costs: Linked to business size or sales volume (e.g., cost of capital, customer support), estimated based on growth rate.

Investors are interested in understanding how marketing spend, customer acquisition costs, and other potential costs may change as the company grows. Creating well-informed models and projections, backed by current actuals, provides a realistic outlook for the company’s future state.