5 things startups should know about VC market in 2023

By Vital Laptenok, general partner at F1V

The year 2023 has brought with it a wild ride for startups.

The economy is in a tailspin, the inflation rates are the highest since the 1980s, the exit environment is the worst in 10 years. And if that weren't enough, the war in Europe does not make things easier.

But despite all the above, the world has recently seen historic growth of financial markets.

We have not experienced anything like this in our lifetimes. Here’s my take on the current trends in the VC market, which can help startups navigate this uncharted territory.

In 2021-2022, VCs invested a lot of money in overvalued companies due to intense competition and lack of due diligence.

The situation has since changed: Despite having raised significant funds, VCs are now waiting for the economy to rebalance, largely holding off on investing. To achieve a more sustainable deal flow, investors are anticipating startups to lower their valuations.

It’s already been happening. I'd say 50-70% of the startups that crossed the $1 billion mark in 2021 are no longer worth that amount.

The number of new unicorns in 2022 was the lowest in 4 years, and existing unicorns are also losing their status. The telling example is Klarna, once Europe’s most valuable private startup, which slashed its valuation from $46 billion to $6.7 billion.

Not all companies have run out of money and accepted the new reality yet. But in 2023, they will have to.

Over the next 2-3 years, investors will play it safe by carefully auditing startups before investing. VCs will be cautious, preferring to back established, “default alive” startups with a proven track record, healthy unit economics, and a viable product or service.

To evaluate a company’s health, the startup and VC industry commonly use the Rule of 40, which requires a company’s growth rate and profitability margin to add up to at least 40%.

In a healthy economy, investors look at fast-growing startups. But in times of crisis, the growth rate of over 30% is rather a disadvantage. As a result, VCs are now shifting their focus to startups with moderate growth rates and positive unit economics.

Startups need to adopt a new approach to company building and money management. The days of WeWork-style excess are over. Instead, startups must operate in a “default alive” mode, using their resources sparingly.

Think of a camel that can survive up to 15 days without water. A camel-startup would use money not to kill competition but to build a solid product and have healthy growth. It wouldn’t splurge on lavish offices and extravagant perks for employees.

Here are a few things to focus on: having a clear strategy for achieving profitability, controlling expenses, maintaining a fair valuation, managing cash wisely, and not scaling just for the sake of scaling.

In the years ahead, investors will pay extra attention to a founder's ability to rely on their own business for survival.

Businesses built on fundamental needs have much higher chances to survive tough times, as people and companies become more cost-conscious and begin to spend less on nice-to-have products.

Here’s a simple analogy: When someone is sick, they buy medicine and painkillers — not vitamins. Similarly, startups that offer solutions to urgent problems are like medicine and are more likely to succeed in the long run.

Our investment team has recently evaluated a startup that simplifies access to medical services for relocated employees. It’s a great example of a “medicine” because when people relocate to other countries, they may face tons of troubles with insurance, doctor appointments, and medical treatment. It’s a much-needed product.

It may seem weird, but a recession or crisis can be a good time to run a startup if founders are ready to face the headwinds.

In hard times, businesses can hire great talent and offer people products or services that solve acute problems. The examples of companies like WhatsApp, Uber, Airbnb, Pinterest, Slack, Venmo, and Instagram, which all grew during the 2008 recession, prove this.

Ukrainian founders are another great example of such resilience: They are building startups during the war, while the national and global economies are slumping. None of our Ukrainian portfolio startups has shut down since Russia started its all-out invasion in 2022.

Founders who create businesses during crises are usually the most motivated, persistent, and capable entrepreneurs. They know their company may not generate high profits within the next 3-5 years. But fueled by their passion for the project, they are willing to work hard and face challenges.

We welcome promising founders of early-stage startups to read more about Flyer One Ventures and pitch us at go@flyerone.vc.

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