Challenging Times Are The Perfect Time To Invest In Startups

By Rachel ten Brink

The last few months have brought a dramatic shift in the market generally, and specifically for Venture Capital. If you listen to media outlets or focus on the late stage headlines, the outlook is quite negative, and it is reasonable that LPs (investors in VC funds) want to slow down and assess where to allocate their capital. However, I would argue that even though things in the last few months seem grim, it is actually a great time to put money to work in Venture Capital. Our view is that the dislocations created by this environment provide for great opportunities to invest in quality companies at attractive terms.

While public market valuations have decreased significantly as interest rates and global uncertainty continue to rise, in turn impacting late-stage deals and cascading to the earlier stages of venture, there are clear advantages to creating an early-stage portfolio in this environment:

Lower Valuations = Increased Opportunities for Investors

Early-stage VC valuations have come back down, allowing for more attractive entry point valuations. The late stage of venture has seen the most dramatic shift due to inability to exit and the impact of market volatility, with Q3 2022 valuations down close to 40% and deal count down 20% from 2021, but the early stage has seen a more measured response. Early stage valuations have also tapered down as deal count slows. For context, pre-money valuation for early-stage deals valuations are down 25% vs 2021, but this is still a strong increase from pre-pandemic levels. The result is more attractive entry points and a more investor friendly environment.

There is also an interesting dynamic happening in recent months—startups that raised a seed last year are choosing to extend their current round rather than raising a larger round at a higher valuation. This gives VCs an opportunity to cherry pick deals that a year ago were just priced too high, even if they had great founders and strong business models. Now investors can come in at the seed-extensions with the same great founders and businesses, but with significant de-risking as the company has demonstrated added traction.

Microsoft, Uber, Slack and Airbnb were all Started During Recessions

Technological innovation is not slowing down; in fact, it continues to accelerate. Many legacy businesses are just starting their digital transformation and new technologies are emerging. Companies are being built today to solve real and scalable problems. Economic uncertainty is a fact, and adaptability is the name of the game, but history clearly shows that great businesses are also built in moments of turbulence. For entrepreneurs who have true conviction, it’s actually a great time to be disciplined and focused on early Product Market Fit, as they may face less competition. Once the economic environment improves, these companies will be ready to scale. While it will be arduous to build in this environment, there are always opportunities for those with the grit, talent, focus and execution.

Now investors can come in at the seed-extensions with the same great founders and business, but with significant de-risking as the company has demonstrated added traction.

Slower Rounds Mean More Investment Rigor

Rounds are moving slower, which enables investors to invest with more rigor to gather more data points over more months, conduct in-depth due diligence, and get to know founders well. If there are lessons to be learned from the recent FTX debacle, it’s that you can’t cut corners when it comes to diligence: from reading every document in the data room, testing the product yourself if possible, getting founder references and speaking to customers, other investors, employees or clients, to fully grasping the financial model and what drives revenue in a business, to how the board operates and how the cap table is structured—diligence takes time. Equally important is to take the time to get to know founders, what drives them, and how to best help them scale.

Constraints Breed Creativity

Building in lean times changes a company’s DNA for good. Founders who set the foundation for their companies in this market will necessarily build differently. History shows that economic downturns are periods of innovation and creativity as entrepreneurs are forced to focus on the most imminent problems facing the world in a capital efficient manner. As an ex-founder myself, I see a lasting effect in building a company in a world where VC dollars are not an endless pool of capital. It requires ingenuity, tenacity and skill, and that’s exactly the type of startup you want to back.

Companies are being built today to solve real and scalable problems. Economic uncertainty is a fact, and adaptability is the name of the game, but history clearly shows that great businesses are also built in moments of turbulence.

Bet on Those Who Can Do More with Less

Founders who know how to do more with less will perform better. Women and minorities have never had it easy when it comes to fundraising (after all, they only get 2% of VC funding) but it will be even harder to raise in these times. Ironically, this is a competitive advantage for diverse founders. Because they have always had to be scrappy, they know how to build lean, efficient teams in any market. The Ewing Marion Kauffman Foundation found that women-led teams generate a 35% higher return on investment than all-male teams. Diverse founders tend to be more careful with spend—a strong attribute in this capital environment.

Top VCs Will Also Rise Above in Tough Economic Times

Just like the most adept entrepreneurs will excel during challenging times, the same can be said for VCs. Savvy investors who have weathered previous down markets and are better equipped to identify and nurture entrepreneurs through turbulent times, as well as funds led by seasoned operators that can give the tactical support to ensure that founders grow sustainably while building a clear path to profitability will rise to the top.

Just like the most adept entrepreneurs will excel during challenging times, the same can be said for VCs.

My prediction is that the next few years will produce exceptional Vintages because these are such difficult times that only the strongest founders will raise and build. As with most economic cycles, investors interest to deploy capital peaks when it is usually a terrible time to invest and the market is overheated, but stay on the sidelines when conditions for investments are at their best. Miss the opportunity to invest in early stage ventures in this downturn at your own peril! (and bonus points if you support a diverse founder or funder, because it’s good for the tech ecosystem and great for returns).

Rachel ten Brink is the founder and General Partner of Red Bike Capital, a woman and Latina-led early stage VC fund based in New York, investing in US-based Fintech, SAAS, and Health and Wellness. Rachel has been a board member and senior advisor for various companies and serves on the Board of Directors of AboveBoard and Dyper. She is co-founder of Scentbird, a Y Combinator-backed ecommerce subscription that raised over $29MM in Venture Funding. Prior, she spent 15+ years building billion-dollar brands at Gillette, Estée Lauder, L’Oréal, and Elizabeth Arden. She was named Entrepreneur Magazine’s 100 Powerful Women and is one of only 90 Latinas to have ever raised over $1M in venture funding.

Follow Rachel on Twitter or LinkedIn, and check out her website.