As we close out Q1 of 2022, the VC industry is experiencing a significant shift in valuations. Gone are the days of founders receiving 20-30x multiples on ARR, with the new reality being closer to 5-7x multiples. This shift is primarily due to a market correction that has been long overdue, but it can also be attributed to the pandemic’s economic impact. As a founder, it’s important to understand how to navigate this new environment and adjust your expectations accordingly. In the current environment, entrepreneurs need to adjust their expectations and focus on building sustainable businesses that can weather economic downturns. In this blog post, I provide advice to entrepreneurs on how to navigate the current environment, adjust their expectations, and focus on the key metrics that venture capitalists are looking for in companies.
Navigating the current environment
To navigate the current environment, entrepreneurs must understand the new reality venture capitalists are living in when deciding to fund a company. Investors are now focused on the core fundamentals of the business, including revenue growth, profitability, and customer retention. In the past, companies with little or no revenue were able to secure funding due to the hype surrounding the technology. However, in the current environment, investors are less interested in potential and more focused on what the company has already achieved. This shift requires entrepreneurs to focus on creating a sustainable business model that generates revenue, controls costs, and has a clear path to profitability.
Entrepreneurs must adjust their expectations about getting funding, even if it means a down round for businesses who already took venture capital funding prior to 2022. A down round is when a company’s valuation decreases, and it is a common occurrence during market corrections. While it may be a difficult pill to swallow, it is important to understand that a down round is not the end of the world. It can provide an opportunity to reset expectations, focus on building a sustainable business, and potentially attract new investors who are interested in the company’s fundamentals.
Important traction-oriented metrics
In this market environment, investors are looking for specific traction-oriented metrics that would cause them to pay more than 5-7x for ARR. These metrics include customer acquisition cost (CAC), customer lifetime value (CLV), gross margins, and net retention rate (NRR). Investors are looking for a company with a low CAC and a high CLV, indicating that the company can acquire customers at a low cost and retain them for a long time, resulting in high lifetime value. Gross margins are also important as they indicate the profitability of the business, and NRR is important as it indicates the company’s ability to retain and upsell existing customers.
In conclusion, while the current market environment may seem daunting for entrepreneurs, it is important to remember that this is just a market correction, and valuations will eventually stabilize. We have previously been living in a world with sky-high valuations, and it was bound to correct at some point. To navigate this environment, entrepreneurs must focus on creating a sustainable business model that generates revenue, controls costs, and has a clear path to profitability. Additionally, entrepreneurs must adjust their expectations and understand that a down round is not the end of the world. Finally, by focusing on important traction-oriented metrics such as CAC, CLV, gross margins, and NRR, entrepreneurs can attract investors even in a market where valuations are lower than in the past.
Hang in there, you can do it.
References material to help guide you: