In the first quarter of 2023, the venture capital industry experienced a banking crisis that involved Silicon Valley Bank, Signature Bank, and First Republic Bank. This crisis resulted from a combination of factors, including aggressive lending practices, overexposure to risky startup loans, and a lack of regulatory oversight. While several articles have been written over the past 45 days that shed light on this situation and provide guidance on how entrepreneurs can protect themselves in the future, entrepreneurs should also understand the other side of the coin. As the venture capital industry adjusts to the valuation reset of 2022, the recent banking crisis has created additional uncertainty about when things will get better. It’s clear that venture capitalists are changing their investing approach. As a result, this blog post will outline the key takeaways that entrepreneurs can learn from this crisis as well as explore how venture capitalists are adapting to the current economic climate and what entrepreneurs can learn from these changes.
Let’s begin by focusing on what entrepreneurs can learn from the banking crisis:
Primarily, it is important for entrepreneurs to diversify their sources of funding. While venture debt may be an attractive option for early-stage companies, relying solely on a single lender for all your financing needs can be risky. As we have seen, if that bank experiences financial difficulties or changes its lending practices, it can severely impact your ability to access capital. As such, entrepreneurs should consider diversifying their financing sources as much as possible, by seeking out alternative lenders, venture debt funds, or even crowdfunding platforms.
Secondly, entrepreneurs need to be aware of the risks associated with aggressive lending practices. Silicon Valley Bank has been known to be more aggressive in its lending practices, and this may have contributed to its current financial troubles. As an entrepreneur, it is important to understand the terms of any debt financing you receive and to carefully consider whether the terms are reasonable and sustainable for your business.
Thirdly, entrepreneurs need to focus more than ever on effectively managing their burn rate. The banking crisis of 2023 made it clear that startups can no longer count on easy access to venture debt or other forms of financing. As such, entrepreneurs need to be extra cautious with their spending, focusing only on the essential expenses required to keep their businesses running. This may mean delaying hiring, renegotiating contracts with suppliers, or even cutting back on marketing efforts. Additionally, entrepreneurs need to prioritize revenue-generating activities, and optimize their operations to maximize efficiency.
Finally, entrepreneurs need to be prepared for the possibility of a prolonged economic downturn. While the banking crisis of 2023 was the immediate trigger for many startups’ financial difficulties, the underlying cause was a more challenging economic environment. As such, entrepreneurs need to be proactive in planning for an extended period of low valuations and tight funding, by focusing on profitability, building up cash reserves, and exploring new revenue streams.
Now let’s explore five ways the VC game has changed post banking crisis and increased economic uncertainty:
- Venture capitalists are placing a higher emphasis on startups with solid business fundamentals. In the past, many startups were able to raise large sums of money based solely on their potential. However, in today’s environment, investors are looking for startups that have proven they can generate revenue and operate profitably. This is especially important given the recent banking crisis, which has made it more difficult for startups to secure financing.
- Venture capitalists are looking for startups that have a clear path to profitability. While VC’s and startups have traditionally focused on growth at all costs, today’s economic environment requires a more measured approach. Startups that can show they have a clear path to profitability are more likely to receive funding, as investors are looking for companies that can survive in uncertain times.
- Venture capitalists are placing a higher emphasis on startups with diverse revenue streams. The recent banking crisis has made it clear that startups with a single revenue stream are more vulnerable to economic shocks. Startups that have multiple revenue streams, or the ability to quickly pivot to new revenue streams, are more likely to survive in uncertain times.
- Venture capitalists are looking for startups that are well-managed and have experienced teams. In the past, investors were willing to overlook management issues if a startup had a great product or idea. However, in today’s environment, investors are looking for startups that have a solid team with experience in both product and business operations.
- Venture capitalists are looking for startups that can effectively manage their burn rate. In today’s environment, startups need to be able to survive on a limited budget, as financing may be more difficult to come by. Startups that are able to effectively manage their burn rate are more likely to survive and be attractive to investors.
Finally, let’s conclude by summarizing both perspectives
In conclusion, the current economic environment and the recent banking crisis have forced venture capitalists to change their investing approach. As entrepreneurs navigate these uncertain times, they should focus on building solid business fundamentals, having a clear path to profitability, diversifying revenue streams, building experienced teams, and effectively managing their burn rate. While the current environment may be challenging, startups that are able to adapt to these changes will be well-positioned for success in the long-term.