Planning to Raise in 2023? Some Advice from a Global VC

By David Cheng and Jiarui Wang at DCM

After a record 2021, VCs have significantly slowed their pace of investing. Crunchbase reported that VC funding in the third quarter of 2022 dropped to $81 billion, down 53% YoY and down 33% from even the previous quarter. Investors have turned somber, as seen in the multitude of guides on how to cut burn, achieve certain ratios for funding, and raise bridge rounds or venture debt.

We at DCM are more optimistic and believe VC activity will start to recover in 2023. A major driver is the record amount of dry powder sitting on the headlines — some $290 billion in all. As valuations slowly reset, investors will be eager to deploy this capital as the bid-ask spread closes. We also see evidence that the public markets may be bottoming out in the markets repeatedly rallying despite the Consumer Price Index (CPI) continuing to rise.

If you’re a founder targeting 2023 for your next round, what should you do? We suggest thinking through the following topics.

Do You Need to Raise?

Some of the founders we’ve seen lately are raising just to have a cushion. We don’t advise this – if you don’t need the capital, you should delay hitting the market and focus on growing the business instead. Showing strong performance through these volatile times will impress VCs and put you in a great position to raise in 2023.

That said, we realize it can be hard to tell whether you need to seek additional funding. If you’re unclear, ask yourself these questions:

• How much runway do you have? We recommend founders have 18+ months of runway if they run at “bare minimum”. In other words, they can stretch their runway to at least 18 months or more if push comes to shove.
• Can you raise from insiders? If you have the luxury of going to your existing investors for an extension round, it may be worth doing so to strengthen your balance sheet. One strategy for this is first approaching investors who wanted to put in more or were cut back in a previous round.
• Can you make more cuts? We’ve already seen many companies make cuts this year. Unfortunately, some may need to make more cuts to extend their runway. Timing is key here — you want to avoid becoming a victim of the current macro environment.

The only exception is startups that are doing well presently may consider raising right now even if they don’t need to. By well, we mean companies who have greater than 2x YoY growth, demonstrate high capital efficiency, and grew into or are growing into their last round valuation. The ongoing downturn has created a flight to quality among investors, so such startups may receive favorable terms at the moment than they would in 2023. Even so, we discourage these fortunate founders from raising just to take advantage of this — the capital should go towards a major growth initiative such as funding R&D, an M&A, or entering a new market vs. “just to have a cushion”.

What Type of Startup Are You?

If you’ve done the exercise above and decided you still want to raise, you should understand how difficult it will be. This depends in part on the type of company you’re building. “Type” can mean any number of attributes, but we think the most important ones are:

• Valuation. Many startups raised at inflated valuations during the bull market and are now finding it difficult to meet them. Investors are understanding of that to some degree, but founders who were more restrained will definitely have an easier time raising in 2023. Put differently — was your last round valuation inflated or have you grown into your valuation?
• Category. Several trends coming out of the pandemic have played out enough for investors to draw conclusions. For example, data infrastructure and collaboration tools have become more important as remote and hybrid workplaces become permanent. On the other hand, rapid delivery startups like Gopuff and Getir have fallen from grace. Of course, some verticals like fintech and healthcare are perennial areas of investments, but this will depend on the specifics of your company.
• Stage. Early stage VC has been less impacted by the slowdown than later stage VC. The biggest driver for this is the general decrease in multiples, which makes it harder for later stage companies to be marked up enough or have sufficiently large exits to be attractive investments. Conversely, earlier stage startups are less likely to be impacted by current market conditions.

We’ve summarized these ideas in the following matrix:

How Should You Run the Fundraising Process?

Even though we expect VCs will be more active in 2023, raising will not be as easy as it was during the pandemic. The easiest, and first thing, you should do is go to your insiders and try to convince them to bridge you or double down — and there are good reasons for them to do so! Because VCs are more careful, you will probably talk to more investors and each of them will have longer diligence processes. This can be a major time and resource sink, becoming a distraction for you and your team from building and executing. More directly relevant to existing investors is the fact that everyone will take on more dilution if new investors come onboard since valuations have come down.

If insiders are unable or unwilling to participate, you should reach out to funds who you have talked to in the past. These investors already know you and can more quickly evaluate your progress since your last conversation with them — ideally, some of these funds were squeezed out of the previous round or otherwise wanted to invest. Another source of potential funding are VCs who are friendly with your existing investors — they can backchannel these friendlies either to help you pitch and seal the deal or shorten cycles, if there’s no real interest.

Although we are optimistic about 2023, we think that net new investors — VCs with whom you and your insiders have no relationships with — will be hard to crack. So if you’re thinking about raising next year, it may be worth your time to start networking now. It is always easier to continue a conversation than to start a conversation, especially when there’s an ask.

What Should You Pitch?

The past couple of years has been all about growth at all costs. How fast can you go? How big can you get? How can you be number one? All of that is still important, but there is a greater focus on sustainable growth and capital efficiency. This is because not only has the cost of capital risen, but access to capital may also be limited in the future.

To help prepare you, here is a non-exhaustive list of diligence questions that investors might ask in 2023:

Growth

• What is your Customer Acquisition Cost (CAC)/payback by channel?
• How concentrated and saturated are your channels?
• What growth initiatives and product roadmap items are you prioritizing?

Unit economics

• What are your gross margins, contribution margins, and historical Lifetime Value (LTV) curves? Note: Many investors have been burned by lofty forecasted metrics, so be prepared to show historicals or for your forecasts to be discounted.
• How will you improve unit economics?
• Do unit economics get better or worse with scale?

Conversion/Retention (on a cohorts basis)

• What does conversion look like at each step of your funnel?
• What is your repeat rate and purchase frequency?
• Is your Net Dollar Retention (NDR) over 100%?

Capital Needs

• How much have you burned cumulatively?
• Where are the largest sources of burn? How do you justify them?
• How much money do you need to go from $X revenue today to $Y revenue by some timeline? How much can you increase revenue without spending more on sales and marketing?

In fact, these are some of the questions we might ask you — DCM is still actively looking for new investments. If you’re a seed, series A, or series B stage company based in the US who is raising (either right now or in 2023), please reach out at dcheng@dcm.com! We would love to see if there’s an opportunity for us to work together.