Fighting for Venture Financing

It’s tough out there for startups right now. With relatively high inflation and interest rates, it’s no longer as easy as it was to find financing. In April, Crunchbase reported that North American funding for new ventures was down 46 per cent in the first quarter of 2023 compared to the same time last year. 

The impact of this new arid lending landscape is quickly becoming clear. Take Montreal-based RenoRun as just one example. The construction materials delivery service was once a darling of the Canadian startup world, posting sales that tripled each year from 2018 to 2021 and forecasted 2022 sales of $120 million. But RenoRun was unprofitable, and earlier this year, after failing to raise needed capital, it shut down operations. The company had struggled to get investors to agree on a financing package. 

RenoRun is not the only new venture feeling these existential threats, says Jon Aikman, a Smith School of Business faculty member, lawyer and investment manager. In the fintech sector alone, larger startups like Clearco and Wayflyer are struggling alongside smaller ones like Pillar and Billi that have closed shop. 

“Look, we’re at the end of the ski hill,” says Aikman, who is also the owner of the artificial intelligence fintech and lawtech firm NordAi and legal services provider Matrix Law. “We went from 18 per cent interest rates in the ’90s all the way down to effectively zero since 2008. It’s fun to ski down the hill, but it’s really hard to climb back up it. It’s just a different world in terms of the cost of capital.”

Yet, as devastating as rising interest rates and ballooning inflation are for startups trying to wrestle money from investors, Aikman says there are other factors at play too. One is the ravenous demand for online services created during the pandemic that has now subsided. Another is that some of the new types of technology that captivated investors’ minds have turned out to be either difficult to monetize (i.e., artificial intelligence) or associated with scams and other criminal activity (i.e., crypto and blockchain).   

All is not lost, however, says Aikman. To secure financing in this new world order, startups must reconsider their competitive positioning. “You have to rethink where you’re at and what you need to get things done,” he says. “You also have to re-evaluate your markets because the old markets and valuations are just not the same.” 

So how do new ventures do all that? Aikman shares a few ideas with Smith Business Insight.  

Drop the ego, drop the valuation 

Dropping the valuation of one’s startup will no doubt hurt any founder’s feelings. But Aikman says it could be one of the smartest things you can do when trying to attract investors in this new climate. 

“There’s a fear of being considered a failure when you do this, but the truth is that you’re not a failure. The failure is bankruptcy, not embarrassment for your investors.” He adds that it’s important to frame any change in valuation as a response to changing market conditions.

As an investor, Aikman says if someone comes to him with an odd high-growth valuation it can be a red flag. “It can make you seem out of touch with what’s going on, and it can make investors think you’d probably be difficult to work with.” The smart entrepreneurs get this, he says, and they stay focused on the big question: What will get me the capital that I need to keep my business moving forward? 

Tie costs and revenues to inflation 

On a more structural level, Aikman says that, if possible, new ventures should consider making their costs and revenues contingent upon inflation. “So, if you’re subject to inflation on the cost side, it is important to link that to your revenues. You can’t have revenues that are divorced from inflation.”

He has seen cases where startups have promised a certain rate for an indefinite period, which turned out disastrous in inflationary climates like this one. 

As an investor himself, he will include terms in loan agreements that are tied to inflation. If inflation goes up, the rate the startup pays goes up. Startups themselves should consider doing something similar with their costs and revenues, he says.      

Be realistic about the future 

If a startup cannot do the above, then they will have to re-assess how they get capital and how they operate moving forward, says Aikman. “And you have to be realistic when you do that. It may be that you have to move towards something closer to debt financing or convertible debt financing to give your investors the safety and security they’re looking for.” 

Operationally, startups may need to adjust amendments to deals and options with key partners like advisers, board members and employees. “A lot of firms went out and gave lots of options to people to incentivize them to work with them or do all sorts of other things that are now worthless because the valuation has changed dramatically,” says Aikman. “So you may need to extend or change those agreements to keep your key people incentivized and working hard.”   

Ditch the moonshot 

During the pandemic, it was relatively easy for a startup to get support for a standalone project that had little expectation of near-term profitability, says Aikman. But post-pandemic, that has changed. “Now these moonshots are not particularly valuable anymore because they’re now seen as expensive lottery tickets. The risk/reward doesn’t add up.” 

But that does not mean the firm has to discard its moonshot idea, he adds. “It could be an interesting opportunity to find other companies that are doing something different to give you certain synergies. Maybe you have a good technology, someone else has a great sales force, someone else has a great back office. You may be able to work together, join forces, and then put something together that investors could see has collective value and staying power.”