The Startup Correction and Why Startups Should Raise Capital Now

If you’re a startup looking to raise money — perhaps you’ve already raised a Seed or Series A — now’s the time to raise more capital for your startup. Though I’m long-term bullish and believe the current market “correction” is a necessary part of the next uptick in our market direction, startups need to raise money now to weather the coming storm... it could get worse.  Remember: always buy your umbrella before there's rain on the ground!  

My thesis is that the startups should raise 2x as much capital to have cash-on-hand for 3 years — not the typical 18 month runway. 

Since August 2015, we're currently at a 10% “correction” in the S&P.   I'd call it a mini-correction at best... but it matters for startups.

We had hovered around the 2000 mark in the S&P from approximately October 1, 2014 until August 2015, varying between 1950 to 2130 for most of the past year. 

The S&P for 2015

The S&P for 2015

It's an interesting tell that the market wasn't able to break through such a pivotal at 2150.

Above, I’ve put a line where the market hit a psychological inflection point and was unable to breakthrough due to world economic turmoil.  Apparently Greece, China, Russia/Ukraine, and the Fed’s indecision impacted our market? Who would have thought?

But this mini-correction does matter for startups and venture capital... and for any new company, period.  

And concurrently, we saw startups raise massive amounts of capital. A lot. 

Startup Fundraising Chart

Startup Fundraising Chart

Even though the market has grown rapidly in the past 5 years.

See here in this S&P 5-Year Chart:

S&P-5-Year-Chart

However, market skepticism has creeped into our daily conversations.  This bearish talk is not conducive to startups and new companies raising capital.  

See below in this Bulls vs. Bears chart:

Bulls vs. Bears Chart 

Bulls vs. Bears Chart 

And the most important chart of all to signal a mini-correction is the Shiller PE Ratio Chart:

S&P-Chart-Shiller-P/E-Ratio

The Shiller chart represents one metric that investors use to determine market fundamentals.  In the private markets of startups, the Shiller index is the equivalent of startup revenue growth.  However, as I argue below investors are talking more about PE, fundamentals, and valuations, so be aware!  

So why should startups raise funds immediately?  

#1 Economic sentiment:  With the Bulls vs. Bears chart reversing trends, it will be at least 6 months before we see meaningful gains in the S&P (and in between we'll see the Fed hike interest rates).  And with the average startup burn rate/runway of 18 months, you might have lost at least 12 months (or more) in runway assuming you're neither profitable, nor raising capital.  Startup CFOs, Board Members and everyone related to a startup, need to get on the phone and tell the CEOs to start raising capital! 

#2 Always buy an umbrella before the storm:  Even if the storm is muted and it sprinkles some rain... the mere perception of global calamity itself ... will cause investors to be more reticent to invest.  

The Fed will raise interest rates in 2015 to at least 25 basis points and the market will respond/bearishly. Though the market should look at this as a positive sign, the immediate reaction will be to the downside (1 to 5 percent) and for investors to park more cash in the bank. 

#3 Price-to-Earnings Matters.  A Users second - Profit first reversal.  Price to Earnings Ratio - is defined as "the ratio for valuing a company that measures its current share price relative to its per-share earnings."  Well, guess what?  If investors in the public markets are starting to care more about valuations (and dividends), you're going to start seeing many more questions of startups such as "when will you be profitable....?" and, "what's your plan to monetize?" Only two years ago, as a venture capital and angel investor, the questions were more geared toward users first/monetize later.  Not so anymore.  

#4 Your valuation is too high!  As an investor at Angel Kings, I get pitched every day by a new startup.   I see tons of startups raising money on Angel List at 10MM valuations, pre-revenue.  It's time to face reality.  Your valuation sucks!  No one cares that you think you're worth 10MM... your numbers now matter.  I don't care if you went to Harvard, Yale, or Cornell (which is a better school, of course :) ) If you're asking for 1 to 2 MM on a 10MM valuation in this new economy, you better be making money!  

I estimate that for every 10% drop in the market, we'll see an average valuation of startups will decline by 30% on Seed rounds, 20% on Series A, 15% on Series B, and 10% beyond to the IPO.  

My recommendation: startups should raise 2x as much capital and have at least 3 years of runway  —  not the typical 18 month runway. And they should also drop their valuation expectations by at least 20%.  This doesn't mean you shouldn't try to raise more, or ask for more money, but be willing to negotiate your terms sheet at a lower valuation.  Though the market uncertainty is hyperbolic and over-reacting, accredited investors are beginning to tighten up and are now looking for steady returns with dividends.  

In other posts, I've discussed reasons why we need to fix our tax code, incentivize innovation by deregulating, and begin exporting Crude Oil abroad, but the reality is that this administration is unlikely to encourage these pro-market policies.  These policies do matter as we need companies like Cisco, Google, Facebook (tech titans) to bring money from abroad, back home, but like I said... in the meantime we face headwinds.

Therefore, if you're a startup - raise capital.  Get out there and be candid with investors.  Make it clear you're in this for the long-haul.  America will survive this mini-correction, but you've got to face the reality, the new market is here and your balance sheets need protection.  

Ross Blankenship

Ross Blankenship

Ross Blankenship