How startups can navigate the current fundraising environment

Fundraising is undoubtedly tougher than it was a few years ago. Some would argue that the environment of 2021 wasn’t healthy, and we’re (hopefully) in the most brutal part of a downward swing. Companies that weathered the storm will emerge as better navigators and more resilient.

Any startup looking to fundraise right now needs to understand that investors’ expectations have shifted — perhaps permanently. To better understand these changes, we spoke with Gyan Kapur, co-managing partner at Surface Ventures, a VC firm that focuses on pre-seed and seed-stage B2B startups in infrastructure and vertical software. Gyan shared his thoughts from an investor perspective, and what startups should think about as they prepare to fundraise.

This interview has been edited for length and clarity.

As an investor, what are some of the biggest changes you’ve seen over the past few years?

The size of series rounds hasn’t gone down as much as people think. What’s changed instead is the number of rounds being done and the metrics needed to raise a Series A. Now, it feels like the metrics are closer to a $2 million revenue run rate, tripling year-over-year. In some ways, the big Series As look like Series Bs used to look. There’s still demand out there. The challenge is just that the bar has gone up a lot.

The other thing is that about 80% of the companies are AI or AI-related. A lot of companies are going after well-known markets with an AI lens. And one challenge I’m having — that I’m transparent about — is that a lot of them look the same.

Broadly, fewer companies are getting funded at the pre-seed and seed stage. I would say the pace of decision-making has slowed down for most VCs. People are taking their time to make a smaller group of affirmative decisions. The filter has gotten stronger. I’d say the average entrepreneur has only partly realized how difficult it is.

What should startups looking to fundraise be thinking about?

One thing worth thinking about is: how do you get “fit”? How can you do more with less? How can we last longer and get to the metrics we need? Because to get to those higher series A metrics, you have to do more with less.

I also think it’s worth asking funds if they have reserves for their portfolio companies. You’re more likely to need a bridge to get to Series A if the bar is super high. Find out and understand even some generalities around reserve strategy for funds because reserve strategies are very nuanced. Ask the fund, “Do you have more money for us, if we’re going in the right direction?”

Generally, there’s a one-way path in terms of round sizes, and there’s a good reason why round sizes have gone up. These big funds have gotten bigger and bigger, so they can afford to wait.

This is why asking about reserve capital is important. If you’re taking the same quantum of capital, but now you’re expected to get three times further, you have to change how you operate with money but also having investors who have more money in case you need it is helpful.

Have some startups started looking for alternative sources of financing?

Some startups certainly do look at revenue-based financing or debt. The challenge there is that the cost of debt has also gone up. Revenue-based financing has also become more constrained because the capital providers to startups in the back end are effectively raising debt too.

I think at the Series B and C stages, they’ll spend more time thinking about debt because revenue is more predictable. Ideally, you’re using debt to fund a predictable cash flow stream, instead of a speculative, equity-like instrument. But yes, people will definitely look more at revenue-based financing or debt to extend their runway, especially if they’re almost at profitability at the seed stage.

But because the cost of those instruments has gone up, it makes the tradeoffs a little more difficult. It’s a tough time in the tech world, period.

What’s your advice for startups looking to raise capital right now?

Ideally, they need to have a plan that gives them more runway than they probably expected. And they need to have higher objectives than they expected, at least compared to 2021 or early 2022.

To do that, they need to be more capital efficient, which means doing more with less. Some of the best businesses ever have been “cash lighter” than you’d expect, even if they raised a bunch of money. If you look at the Googles of the world, or the Slacks of the world, they raised a bunch of money that sat on the balance sheet. It was either used to re-value the business or deal with intra-month cash flow cycle issues because they were growing so quickly.

If you have a big cash balance sheet or you raised a bunch of money, you could use that to your advantage. One way is that you have higher interest on your cash flow and can use that to offset some of your cost structure. So if you raise $20 million and you haven’t spent a lot, you might be able to generate $600 or $700k in cash from interest. That is potentially a few FTEs from just interest “revenue.”

The good thing is that companies that are able to be capital efficient tend to be positioned really well as enduring businesses. Long-term, if you don’t burn a lot and you generate a lot of cash flow, you’re valuable. Those companies are hopefully going to keep that ethos for a long time.