5 Steps To Survive Venture Capital’s Deep Freeze

Over the last several decades, the venture capital (VC) industry has gone through significant emotional swings. What should business leaders should do when VCs tell them to cut costs before the next round of capital? Read on for advice from a CEO whose startup just raised $50 million in the midst of the current VC deep freeze.

When the economy is growing and the initial public offering market starts to light up, VCs are possessed by a bad case of Fear of Missing Out (FOMO). FOMO drives VCs to tell their portfolio companies to spend all the money they need to grow at over 100 percent a year as they sprint for the IPO market.

Every few years, FOMO quickly turns to Fear of Losing Everything (FOLE). That certainly happened in a big way when the dot-com bubble burst and during the financial crisis of 2008. It’s easy to see it coming ahead of time — it’s usually preceded by a burst of IPOs and a soaring NASDAQ — which is what happened in 1999.

Last year, I was expecting FOMO to turn quickly to FOLE due to the rapid growth of Special Purpose Acquisition Companies (SPACs) and the record levels of VC investment. I did not know that the Federal Reserve’s decision to begin a campaign of interest rate increases would trigger the emotional reversal.

To be sure, it was more complicated than that. As the New York Times reported, [the change in VC attitudes] is due to the end to a “decade-long run of low interest rates, the war in Ukraine [that is] causing unpredictable macroeconomic ripples; and big tech companies — such as Amazon and Netflix — whose shares are faltering,”

VCs are increasingly telling their money-burning portfolio companies not to expect another check. In the first quarter, U.S. venture funding fell 8 percent to $71 billion; over 55 tech companies have announced layoffs or shut down since the beginning of the year, compared with  25 this time last year; and as of May 4, IPOs were down 80 percent from the year before.

For startups founders, the problem can be explained by looking at the four stages of scaling about which I wrote in my 2019 book, Scaling Your Startup:

1. Winning your first customers. When a startup finds a fit between the needs of customers and the product they are developing, it can win customers
2. Building a scalable business model. Before taking on significant amounts of capital to grow quickly, the startup should redesign processes — such as selling, product development, and customer service — so the startup has a clear path to profitability as it grows.
3. Sprinting to liquidity. The startup accepts significant amounts of capital which it spends on sales, marketing, and product development so it can grow quickly to over $100 million in revenue — enabling it to go public.
4. Running the marathon. The startup goes public and must sustain revenue growth in excess of 20 percent so that its stock price continues to rise.

While writing the book, most startups obeyed the FOMO-infused VCs’ demands to spend what was needed to grow fast. In short, they skipped the second stage of scaling.

Now that FOLE is the emotion-du-jour, VCs demand that startups do the stage they previously told them to skip. Publicly-traded companies that never completed the second stage — such as Uber — are now trying to do that. 

San Francisco-based Mutiny, a four year old, 49 employee operator of a website personalization platform to help companies boost sales, raised $50 million in April at a post-money valuation of $615 million, according to Pitchbook. 

Mutiny’s investors wanted to invest because their portfolio company CEOs said Mutiny’s product helped them grow faster.

How so? As co-founder and CEO Jaleh Rezaei — whose two Stanford degrees include an MBA — told me in a May 11 interview, “By customizing a company’s Website based on what a potential customer is searching for, one client’s conversion rate increased by 60% (where 10% is huge). We reduce wasted marketing spend from $19 out of $20 spent to $18 so companies boost revenues by 50 to 100 percent.”

Rezaei said Mutiny had little difficulty raising capital because it passes five tests:

• Solve a big problem
• Aim at a large market
• Make the customer much more successful
• Build a culture that attracts and helps the best people realize their potential
• Tighten your unit economics — e.g., complete the second stage of scaling before taking on large amounts of capital