United States: Headwinds In Venture Funding: Strategies For Companies In 2016

By all measures, much of 2014 and 2015 were strong years in venture capital funding. The current forecast is, however, less optimistic for founders looking for venture backing; the end of 2015 saw a pullback in private investing and trends for the start of 2016 demonstrate caution among investors.

2014 and 2015 in Review

The Fundraising Report released by Thomson Reuters and the National Venture Capital Association (NVCA) in January revealed that U.S. venture firms committed $28.2 billion over 2015 and $31.1 billion in 2014, making the past two years the strongest since the economic downturn began in 2008.

According to the NVCA report, the decline for 2015 is attributable in large part to the uptick in caution and dip in new private investment in Q4. Valuations soared through much of 2015, with 60 unicorns – those tech startups reaching valuation of $1 billion or more – established worldwide in the first three quarters, and median U.S. startup valuations ranging between $50 and $70 million during the same period. Moving into Q4, investors pulled back significantly with only 12 new unicorn valuations worldwide and U.S. startup valuations dropping to a median of $27.5 billion – a 60% decrease from Q3.

A combination of factors appears to be contributing to fatigue in the private investment market, including general economic slowdown in China and uncertainty in the region; longer average time to initial public offerings (IPOs) for startups and, increasingly, technology IPOs falling short of their private valuations; and growing likelihood of U.S. interest rates rising, which would offer institutional investors potential for stable returns without the risks associated with investing in new technology.

New technology continues to dominate the available venture capital landscape and within the U.S., California, New York and Massachusetts remain the leading markets for venture capital investing.

  • Enterprise technology solutions focused on mobility, cloud-computing, data security and analytics attracted much of the venture capital funds over the past year, with many startups finding eager corporate investors as an available source of capital.
  • Internet and mobile technology, including ongoing focus on the Internet of Things, remain attractive to private investors, though a sustained focus on privacy by regulators requires that founders be watchful of the regulatory landscape and engage in privacy-by-design where possible.
  • Education technology may be a singular area that remained strong through the close of 2015, and founders in this sector must continue to focus on profitability and solutions that satisfy the varied stakeholders involved in private and public education.

Strategies for Startups

The Wall Street Journal recently highlighted sound advice for surviving in the increasingly cautious venture capital marketplace. Founders should consider focusing on the following:

  • Business Basics. With lower confidence in the air, investors are looking for sustainability and proven business ventures when taking a share of the company. It should come as no surprise that many of the most successful founders have a background in business and finance and putting those fundamental disciplines to use may set emerging companies apart as competition for funds increases. Positive cash flow and profits, or strong evidence that those critical business elements are on the horizon, are more likely to win over cautious VCs in 2016.
  • Cutting Expenses. Startups may inevitably continue to struggle between offering perks that attract the talent necessary to grow and maintaining fiscal responsibility when it comes to in-office benefits. Decking out workspaces with food, recreation space and perks like on-site gyms may boost employee recruitment and morale, but at what price? Management teams for emerging companies must think carefully about whether such expenditures could cost more in the long term, with many startups that saw initially high valuations now cutting such perks, and even their workforce, in order to achieve sustainability.
  • Alternative Funding. Raising debt may help tide over companies without resorting to selling shares at a lower price. Convertible debt can be a way to bridge valuation challenges. For companies looking for initial investment, crowdfunding – arguably a startup financing model itself – may offer an attractive, albeit potentially labor-intensive alternative. The World Bank estimates that crowdfunding will increase to $90 billion worldwide by 2020, and successful crowdfunding has the potential to demonstrate public enthusiasm when founders pitch other private investors, including angels and VCs.

Competition in fundraising has always been part of the challenge for early stage companies. When facing a more challenging financing environment, it becomes even more important for emerging companies to focus on their bottom line and find ways to set their company apart in the eyes of investors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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