The trends in business financing problems that began earlier this year have thus far not improved. Given current market and inflationary pressures, changing investor behaviors continue to be highly cautious about throwing money at startups. As a result, many new companies are struggling to piece together resources to stay afloat. However, startup funding challenges have certainly led to some creative strategies among some. And despite the bad news regarding funding supports, some startups are still finding their way through the quagmire. This is where their true entrepreneurial spirit can come in handy.
There’s little question that the current climate is not ideal for startups needing financial help. But not all the news is dismal, and based on a deeper dive into the numbers, there is reason for hope. That means companies finding ways to deal with startup funding challenges in the short-term may weather this storm. It also suggests that business financing problems may be self-limited, ushering in new opportunities in the months to come. With that in mind, let’s take a closer look at the current venture capital environment and some options worth consideration.
“It’s cockroach time — do whatever it takes to survive. A little bit gross but it kind of works. If you can survive the next two, three years, you’re probably going to thrive.” – Tessa Wijaya, Co-founder of Xendit, a digital payments startup firm
Startup Funding by the Numbers
Before we provide a more comprehensive analysis, it’s first worthwhile to provide actual startup funding figures concerning startup funding. In this regard, there’s little good news if we’re comparing current startup funding challenges to recent years. Through North America, startup funding dropped across the board for the 3rd quarter of 2022. For this quarter, investors spent $39.7 billion in seed and growth stage funding. This was down 37% from the 2nd quarter of 2022 and 53% down year-on-year. Similar trends had already been seen in earlier quarters of the year, making current drops even more substantial. As a result, it seems business financing problems are persisting.
While all startups faced a tough VC environment, some companies were affected more than others. Specifically, those in tech sectors and late-stage startups saw the largest decline in funding access. For these sectors combined, Q3 funding dropped by 45% over Q2 funding. In comparison, business financing problems for seed and early-stage startups were less intense. These saw declines of only 18% and 28% respectively over Q2 figures. Regardless, all experiences some degree of startup funding challenges, particularly those who were behind already. Current investor sentiments making it quite difficult for some to bridge their funding gaps.
“A lot of late-stage companies raised capital in 2021. A few of them may not have raised enough and so will be under pressure with the market slowdown.” – Rahul Khanna, Managing Partner, Trifecta Capital
Explaining Current Business Financing Problems
In analyzing these current startup funding challenges, there are some explanations that are readily apparent. Stock market declines play a significant role in this regard. Specifically, declines in the tech and biotech sector have forced investors to reconsider things. In the process, valuations are being reassessed, and lower valuations naturally mean less funding. At the same time, inflationary pressures and market contraction is creating a less favorable investment climate as well. Unless startups are demonstrating clear profits currently, risks associated with additional funding are higher. This too has contributed to business financing problems.
In part, risk behaviors also help explain why late-stage startup funding challenges are most pronounced. When it comes to early and seed funding rounds, the amounts required for funding are typically less. In fact, most of these funding deals are around $2 million or less. In the last year, only 25 deals exceeded $15 million. In contrast, late-stage rounds tend to be much more. With a more unfavorable economic and market climate, this means investors are more concerned in allocating funds to these companies. This helps explain why startup funding challenges are affecting these businesses more that earlier-stage ones. And it also explains why mergers and acquisitions as well as IPO exits are much less common for 2022.
“Convertible notes (are) a good option for entrepreneurs (with) confidence to pull off an (equity) round in the next one year or so and discount the notes in that funding round.” – Ashwin Damera, Cofounder of Eruditus, an edtech startup
Creating Ways to Deal with Startup Funding Challenges
In dealing with business financing problems, startups are having to get creative. For the lucky ones, particularly those in later stages, earlier funding could save the day. If they were able to ride the 2021 wave that saw significant funding rounds, adequate capital may exist for survival. Combined with cutbacks in spending and reductions in growth expectations, these lean companies might make it to better times. But for other companies, including earlier-stage startups, this may not be an option. As a result, some are leveraging convertible notes as a way to raise capital. This appears to be a good solution for some with startup funding challenges.
Convertible notes are basically notes that startups provide potential investors in exchange for current funding. While investors will not be able to receive shares currently for their contributions, they will in the next round. And during this next round, they will enjoy a discounted price per share because of their prior contributions. On average, these investors receive a discount of 2% off the share price for each month that passes. Naturally, this benefits startups currently with business financing problems by providing needed funds. But there are other advantages as well. Convertible notes do not require startup valuations, and they also do not require monthly or quarterly servicing of debt. And while many later-stage companies are using this approach, some early-stage startups are as well.
The Potential Silver Lining
While current startup funding figures have clearly declined this year, there are some positives amidst the negatives. First, the fact that investors still see seed and early-stage startups as investment opportunities is favorable. This suggests they anticipate a market return over time. At the same time, there has been some major acquisitions this year and a few big IPOs. In other words, the well is not completely dry. Lastly, despite a decline from 2021, figures from 2022 are comparable to 2020. This indicates that business finances problems are not as dire as they seem. All these things considered, hopefully startup funding challenges will be short-lived. But for now, a cautious, conservative, and perhaps creative approach is the one best considered.