Venture capitalists put $68.4 billion to work in early-stage investing in 2022, but the dollars are not flowing nearly as smoothly as they did in 2021.

Just $10.7 billion was invested in early-stage transactions in the fourth quarter, less than half of the amount raised in the first quarter of 2022, according to PitchBook and the National Venture Capital Association. Late-stage deals raised $13.5 last quarter, the lowest quarterly total since 2018. Overall, U.S. VC deal value fell by 31% last year, to $238 billion.

Being savvy investors, venture capitalists are pumping the brakes on new commitments. “Unable to justify the sky-high valuations seen in 2021 and retreating from the ‘growth-at-all-costs’ mindset of recent years, many investors are pulling back until the ecosystem returns to a more palatable normal,” said John Gabbert, founder and CEO of PitchBook. 

“The lethargic pace of exits,” according to PitchBook’s and the National Venture Capital Association’s Q4 2022 Venture Monitor report, hasn’t helped. Just $71.4 billion in total exit value was generated in 2022, a massive drop from 2021’s record $753.2 billion in exits.

  Christina Ross

Said Christina Ross, a former CFO who is now CEO of FP&A platform Cube: “Where [VCs] are putting their time and capital is in supporting their existing companies. So, if rounds are getting done, they're typically internal rounds, and a lot of them are bridge rounds [interim financing rounds raised between larger ones] to help companies whom [VCs] still believe can make it through the storm to the other side.”

Yes, life is now tougher for early, mid-, and late-stage venture-financed startups. And potential pitfalls abound. Whether a startup is raising capital for a Series A or D or just trying to stretch funds between rounds, finance executives and founders need to keep the following in mind.

1. Be better at articulating the vision. “And when you articulate that vision, be that much more clear on how you're going to execute the strategy to achieve your mission,” Tasneem Dohadwala, founder of Excelestar Ventures, told CFO. “I know that sounds very ridiculous and lofty and yet it's actually really critical.” Many companies that pitch to Excelestar don’t have a clear vision or can’t articulate it. Founders need to be clear and crisp, “because money is going to be scarce and funders are going to be scrutinizing more than they have before,” said Dohadwala.

  Tasneem Dohadwala

2. Fund-raise ahead of time. Dohadwala recommends companies give themselves at least six months to raise a multimillion-dollar round. “If you’re out of cash in June you should be fundraising in January; if you’re fundraising in April you’re too late,” she said. The time is needed to excite investors, agree to terms, perform due diligence, and undergo legal review. 

Founders should not wait for current market conditions to improve to raise capital, wrote Ginger Chambless, head of research for JPMorgan Chase commercial banking, in the Pitchbook-NVCA Q4 Venture Monitor. “Valuations are likely to be down regardless, and we expect a crowded field of companies looking to raise later this spring to early summer,” she wrote. 

In addition, said Dohadwala, startups should pursue multiple fundraising strategies simultaneously. “If you have a $20 million round you're trying to raise, you may try to do a $10 million insider around and you may be thinking about a strategic investment,” she said. “The companies that are going to be successful are going to have a lot of irons in the fire and those that aren’t frankly are not going to be successful.”

3. Don’t over-raise. Startups may be tempted to take as much money as they can, something companies mistakenly did when valuations were sky-high. Don’t. Venture capitalists have to deliver returns to their limited partners in a certain timeframe. The more money a company raises, (which generally means a higher valuation) the greater will be the expectations and the more the company has to deliver, said Cube’s CEO Ross. 

Overfunding a company is like over-watering a plant said Ross: it leads to premature death. “It’s not like if you get more money you get to keep it in the bank,” said Ross. “If you over-raise, you have to put that money to work; you can only spend and grow your capital so quickly; you can only hire people of a certain caliber so quickly; you can only acquire companies with the right amount of due diligence so quickly.” Overfunded startups get sloppy with their capital, she said.

When you learn to live without, you're more efficient with your spend; when you have a lot more [capital] it tends to introduce bad behaviors. — Christina Ross, CEO, Cube

4. Take only what you need. A corollary to the above rule is to only take only the amount of capital you need versus the amount VCs are offering. A rule of thumb for a raise is the amount of capital the company needs for the next 18 to 24 months. More than that and the company may lose its operating discipline, said Ross. “When you learn to live without, you're more efficient with your spend; when you have a lot more [capital] it tends to introduce bad behaviors,” she said.

When fundraising markets were flush, some companies took “opportunistic” capital. “Venture capitalists would show up and say, ‘we really love your business, we want to give you a term sheet,’” said Ross. And the company would take the money despite not actively fundraising. But taking too little capital in a fundraise is also dangerous because the company needs not only funds to keep the business afloat but also money to invest in future growth.

5. Everyone is tightening their belts. “There are all kinds of new cash constraints that go into the large equation of your cash needs,” said Dohadwala. Customers may be wary of awarding business to new young companies; suppliers may be faced with delays, and delays for a young company are costly; inflation has increased operating costs; and talent is much more expensive, Dohadwala said. “All that has to be baked into the cash model.”

A deteriorating macroeconomic environment in 2023, means venture markets are likely to remain challenged in the near term, according to Chambless. “Founders will need to continue to dial back cash burn where possible to extend runway,” she wrote. “This is especially true in Series B or later, where the gap between valuations at the last raise and current market realities is the largest.”