While no two downturns are the same, it helps having been around the block a few times. In this letter to founders, Mosaic’s co-founder and partner Toby Coppel shares his view on how the market volatility impacts venture capital and gives advice to founders on how to survive a bear market.
The bull run over the past 10 years is over. As a result, there has been a massive drop in growth and late stage investment, causing that part of the market to freeze. The biggest opportunities for value are now in the public markets and the crossover funds have pulled back from growth investing to focus on the public markets and/or looking at earlier stage bets. Later stage has been affected first but animal spirits have been impacted at all stages and this is being felt at early stage already with a slow down in financings as investors spend time triaging existing portfolio companies and decelerate their pace of fund deployment to more sustainable 2.5 - 3 year fund cycles.
So how does this impact fundraising? Valuations and round sizes have been materially reduced at all stages and the hard truth is that many rounds are simply not getting done at all. Even though you may read about lots of rounds being announced, these were often closed months ago. At Mosaic, we can see no reason to believe that the market is going to change any time soon. In fact it may get worse if the economy slows further due to interest rate hikes and potentially moves into recession in the next 6-12 months.
As a startup, cash is your oxygen and we believe that founders should plan for the worst and have enough of a cash buffer to survive that worst case scenario. This means if you don’t have 2-3 years of cash runway today, you need to find a way to get there. Simon and I lived through the 2001 dotcom crash in Silicon Valley and have the scars to show - it was 3-4 years before the market came back to life. Getting there will require making yourself attractive to new investors, with a cash efficient model of growth: strong unit economics and payback on marketing and a burn multiple close to 1.
Companies that don't do this will likely not be able to raise or have to accept damaging structure (we are already seeing >1X liq pref and IPO ratchets discussed). We don’t believe that debt is the answer given the reduction in operating flexibility it creates, and in practice most debt providers will seek additional guarantees that you can't provide.
When planning for your worst case scenario, we recommend you take into account that a softening economy will impact enterprise budgets and consumer’s wallets, so you should assume your growth will be slower than expected and you will need to replan top line. In a downturn some industries continue to spend more than others (e.g. healthcare) and we think that marketing pitches focused on cost reduction and ROI are likely to be more successful than those attuned to revenue growth. Many of our portfolio companies are ensuring teams are returning to the office in order to strengthen culture given the challenging environment.
While this might sound disheartening, this environment does present some opportunities . It's an opportunity to redefine culture in the company, many CEOs take the opportunity to switch to wartime mode. We are seeing talent available from public companies in a way that it has not been in the last few years given stock prices have dropped as much as 80% from peak. The FAANG all have hiring freezes. You may also see M&A opportunities as companies struggle - we recommend you have a target list so that work is done in case these opportunities arise.
1) Act fast
2) Develop a conservative financial plan that allows you to survive in the worst case scenario
3) Freeze hiring and replan headcount. Consider headcount cuts
4) Cut all non-essential sales & marketing spend
5) Make the decisions now that you wish you had made when you are are down to <6 months of cash
6) Top up your cash balance. Down is the the new up round so expect you will have to take your medicine
Mosaic’s philosophy is to invest throughout all parts of the cycle and we have maintained a consistent pace of investing over the past 8 years since we were founded. We typically invest in 6-10 companies per year at early stage.