Commentary: Venture or vulture capital? Start-ups desperate for cash face hard fundraising rounds ahead
As economic uncertainty grips the world, start-ups may find it challenging to raise funds in this climate. At a time when venture capital can be perceived as vulture capital, Vickers Venture Partners’ Finian Tan says funding hasn’t exactly dried up.
SINGAPORE: Southeast Asian start-ups had a good 2021, raising a record US$25.7 billion in funding. However, as the world heads into its worst macroeconomic crisis in more than a decade, it’s had a severe impact on start-up funding - a “funding winter”.
Many in the venture capital (VC) industry argue that this is a good thing: It moves away from start-ups being over-capitalised – taking in too much capital and valuing the business much higher than what its assets and growth plans are actually worth, winnowing the field to leave more rewards for stronger businesses.
Indeed, much of the narrative today is about profitability rather than burning cash to chase growth.
However, such arguments are not new, as they have followed every cycle of funding slowdown.
Yes, profitability is a necessary objective for start-ups at some point, but start-up founders are also pushing back more strongly against VCs wielding this narrative to negotiate poor valuations for start-ups desperate to raise funds.
PERCEPTIONS OF OPPORTUNISTIC BEHAVIOUR
“Vulture capital”, often used to generally describe such behaviour by VC funds, actually describes something else: The corporate raider model popular in the 1990s where VCs bought and liquidated poor or distressed firms for a quick profit.
It isn’t quite what is happening today but misnomer aside, there is little doubt that start-ups are fighting back against what they perceive to be opportunistic VC behaviour trying to capitalise on a weak market.
Stories, such as Swedish “buy now, pay later” firm Klarna’s valuation plunging 85 per cent in just one year when it raised funds in July, add oil to the fire. But while major VC firm Sequoia received the most attention, Klarna’s latest fundraise also included a bank, a sovereign fund and a pension fund.
IS THERE REALLY A START-UP FUNDING WINTER?
Is it indeed harder for start-ups to raise funds? Yes, that is most likely true based on feedback from start-ups. But is that because VCs are less inclined to invest? The data shows otherwise.
According to a Forbes Finance Council member’s analysis of Crunchbase data, funds raised globally by fintech companies in the first half of 2022 actually increased in pre-seed rounds, up 29 per cent compared to the same period in 2021. Bear in mind, 2021 was an exceptional year in fundraising, where investor money flowed freely.
There were dips in seed, series A and series B funding, but a look at average deal sizes across the four rounds shows that all four rounds showed average increases, from 9.48 per cent (series B) to as high as 120.33 per cent (pre-seed).
This means that on average, companies that were successful in raising funds had actually raised more money, even when compared to the giddying heights of 2021. This is corroborated by data showing a drop in the number of deals.
Only series C fundraising saw significant dips in the amount raised and average deal size, which makes sense due to poor stock market performance limiting the prospect of a good initial public offering (IPO) exit.
This suggests that deals are still flowing, but that funds are being concentrated on fewer companies than in 2021.
INVESTORS ARE PLACING FEWER BUT SURER BETS
This upends the perception that venture is turning into vulture capital. Were that true, the data would show more and smaller deals being closed, because there really is no shortage of companies in desperate need for cash today and investors could have picked them up at more favourable valuations.
Despite the popular narrative of the pace of dealmaking “grounding to a halt”, and what little investments are secured on the cheap, the actual data shows anything but.
Funding winter or not, the anticipated outcome is similar: Investors are simply punting less and making surer bets, rather than spreading themselves across more start-ups.
So where is this perception coming from?
At a time when high-profile tech companies like Sea have been laying off employees as they pivot from hyper-growth at a loss to focus on profitability, founders looking at companies like Klarna are attributing the fundraising changes to investor pressure. But growth and profitability are not mutually exclusive.
VENTURE OR VULTURE CAPITAL
That said, there will still be good and bad VCs. How then does a founder distinguish between a venture capital and a vulture by today’s definition?
In the simplest definition of the word "venture", it is to dare to undertake risks. VCs see that our entire reason for being is to take risks into innovation and ideas – compared to other investors.
It is why we often go all in on start-ups, as opposed to other types of funds that might diversify into investment products such as bonds and securities.
A good VC doesn’t only look at a start-up’s potential profitability and scale, but also shows a belief in the founder’s values and mission. They take the time to understand and experience the company’s products, assess the market risk and lend their expertise to guide the founders toward future rounds of fundraising. Some might even leverage their network to help the company secure commercial contracts.
There will always be some sort of friction between a founder and an investor, but whether a VC shows deep understanding of the risks involved and cares about the long-term viability of the business can be telling – often from the very first pitch meeting.
Finian Tan is the chairman and founder of Vickers Venture Partners.