In a strong economic market, startup founders have the benefit of raising from investors who are risk-tolerant and optimistic. But when conditions tighten or become more uncertain, investment can be harder to secure. Venture capitalists may shift focus to divert more funds to their current portfolio companies rather than seek new opportunities. That means that, in order to capture investor attention in a down market, startups seeking early-stage funding usually need to adapt their tactics — including focusing on the right metrics to demonstrate clear market opportunity, early signs of traction, and clear growth potential.
The state of fundraising for early-stage founders today
Before we dive into how to fundraise in a down market, it’s helpful to do some level setting on what raising in a down market entails. The current economic forecast is clouded by rising interest rates and market declines, and fundraising has slowed dramatically across all stages of venture-backed startups.
But despite the challenges facing founders across growth stages, deals are still being made — particularly at the early stages. “The markets are still open for companies with a unique insight and a painkiller solution,” said Meka Asonye, a partner at First Round Capital, in a recent conversation with Mercury’s head of community, Mallory Contois. “I've seen companies with five, six, or seven term sheets, which feels like a throwback to 2021. The only market that matters is the market for your equity. You will set the bar for what kind of reception you get."
Metrics that matter for early-stage fundraising in downturns
With that in mind, the reality is that early-stage founders can still raise capital in a down market — it will look slightly different.
“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.”
Founders need to approach their fundraising efforts more strategically, including metrics in their pitch decks to persuade investors they’re building businesses with the potential for long-term viability and profitability. To that end, these are a few metrics to consider when pitching investors in a tight market:
Burn rate and runway
Burn rate refers to the pace at which your cash reserves are depleting. In any market — but especially in a down market — it’s important to know and monitor your burn rate since running out of cash is why most companies fail.
There are two different types of burn rate: net and gross. Your gross burn rate corresponds to how much cash you spend in a single month (i.e., cash outflows). Net burn rate subtracts the total revenue from the total money you’ve spent month-over-month. In other words, your net burn rate is your actual cash lost in a single month because it’s based on the difference between expenses (the cash outflows) and revenues (the cash inflows).
To calculate a rough estimate of your company’s runway, take the amount of available capital and divide that number by the net burn rate to determine how many months you have before your startup runs out of cash. Keep in mind that the number you get from the calculation will be dependent on consistent expenses and revenues, so any anticipated changes or fluctuations should be considered in addition to this basic formula.
For investors, these numbers — your burn rate and runway — illustrate the efficiency of your business, your ideal fundraising timeline, and your company’s capital needs. While startups often keep their operations and expenses relatively lean until their first fundraise, VCs want to know how you plan to sustainably invest back into your company with new capital infusions while still considering healthy spend management and runway.
Did you know?
Mercury allows you to open multiple checking accounts so you can easily organize your finances.
Total addressable market
Calculating the total addressable market (TAM) for your early-stage startup is an essential step for your growth strategy as it’s an indicator of product-market fit and market opportunity. TAM is the calculation of the maximum size of the market demand for your product or service. It helps you understand the scope and urgency of the problem your startup is solving, which speaks to your target customers’ likelihood of using (and paying for) the solution you’re providing.
There are a few different ways to assess TAM for an early-stage startup:
- Top-down approach: The top-down approach relies on using existing data from a credible source — government census data, for example — to estimate the size of the market you’ve identified as your target customer. This approach is quick but can also be inaccurate as it relies on external sources.
- Bottom-up approach: The bottom-up approach is a more realistic and reliable way to calculate TAM, as it considers the unit economics of your business (based on previous sales and pricing data), as well as comparative industry data based on your category. This approach helps you understand your target segment better and allows you to identify key market drivers and a reasonable estimate of the market share you’re likely to capture.
- Value theory approach: Value theory measures TAM by estimating how much value your users get from your product or service and what they’d be willing to pay for it now and in the future. This approach is flexible but can also be speculative because it relies on your assumptions about your customers.
Customer acquisition and customer acquisition cost (CAC)
Venture capitalists want to see healthy user acquisition numbers. Is your startup adding new users consistently? Is it retaining them? How many people are paying for your product? Having answers to these questions in conversations with investors is essential to demonstrate clear traction, growth potential, and value-add to your user base.
One of the particularly crucial metrics around customer acquisition is customer acquisition cost (CAC). As the name implies, CAC refers to the average cost of acquiring a customer and typically includes any costs associated with advertising, sales, marketing, and onboarding.
It’s natural as your company grows for CAC to increase since you’ll be spending more to capture a bigger piece of your TAM. Still, constantly increasing CAC could signal that your marketing and sales aren’t as effective as they should be — especially if you see CAC increasing while customer quality is decreasing. But if CAC is increasing alongside rising customer lifetime value (LTV), those costs can be better justified.
Ultimately, the goal should be to increase ROI on costs associated with acquiring new customers, whether that means reducing CAC or increasing overall revenue or LTV. Generally speaking, the ideal LTV/CAC ratio for high-growth early-stage companies is 3:1, meaning you make 3x as much from a customer as it costs you to acquire them. Keep that in mind as you consider what story your metrics tell investors about how sustainable your business model and growth strategy are.
Perhaps most importantly, investors want to see a financial model that shows you have the flexibility to save capital when necessary and ramp up spending when the economic environment allows.
Creating projections involves making future versions of financial statements to show how your business will look — which ultimately requires making a good deal of assumptions and educated guesses. Because investors know this, they’re primarily looking for the “why” behind your projections — explanations of how your current numbers or particular growth model (i.e., sales-led growth or ads-led growth) support the estimates you’re laying out.
Your financial projections should factor in two buckets of expenses: fixed costs and variable costs. The fixed costs are things that aren’t really dependent on business or sales volume (e.g., payroll, office space) whereas variable costs are those that are closely linked to the size of your business or sales volume (e.g., cost of capital or customer support). When building projections, you can largely operate under the assumption that fixed costs will remain the same, but the variable costs — which will shift as you scale — can be estimated based on your growth rate.
From there, focus on layering in robust assumptions about how you see your company’s finances tracking over the coming months and years. How will your marketing spend change as you grow? What might customer acquisition costs look like? Take potential costs into account and start creating informed models and projections that paint a realistic future state of your company that you can back up with current actuals.
What startup qualities do investors look for beyond the metrics?
Beyond planning your pitch around the right metrics, there are other things you can do to prepare for conversations with investors. Keep these guidelines in mind when planning for your next round of funding.
- Set realistic expectations. When markets are uncertain or changing, fundraising is going to follow suit. VCs in tighter markets will naturally have higher expectations for your business and may value you more conservatively, which may take longer than you expected to raise. Going in with a clear understanding of the current environment can help you keep your expectations aligned with reality, thus setting you up for a smoother process.
- Focus on your value-add. Offering a product or service that goes beyond the table stakes and does something truly differentiated for a specific audience can give you an edge. Keep that in mind, and consider how to get that clear value across. In some cases, the metrics help illustrate the story (e.g., high customer acquisition numbers), but it also helps to have qualitative proof, such as feedback from early customers.
- Build from experience. Venture capitalists are de-risking their investments. As a result, they are more encouraged by founders who have operational, startup, or industry experience — as well as a personal connection to the problem they’re solving. Consider how to bring that element to your pitch, and remember that fundraising is as much about building a working (and lasting) relationship between a founder and investor as it is about closing a deal.
The current environment is less about taking a step back and more about putting the best foot forward. With the right strategy and considerations in mind, early-stage founders with a strong company and potential for growth can still secure the venture deals to move their company onward and upward, despite raising in uncertain times and market conditions.
Maya Kosoff is a content strategist and editor based in Brooklyn, New York. She specializes in early-stage startups and venture capital. Her work has been featured in the New York Times, the Washington Post, Business Insider, Vanity Fair, and more.