Wednesday, June 29, 2022

It’s time for the Australian startup sector to brace for turbulence

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Shreya Christina
Shreya has been with for 3 years, writing copy for client websites, blog posts, EDMs and other mediums to engage readers and encourage action. By collaborating with clients, our SEO manager and the wider team, Shreya seeks to understand an audience before creating memorable, persuasive copy.

I was in North America last month, meeting a lot of investors and founders, at different stages and sectors, from all over the region.

Some focused on early-stage consumer-focused startups, where they saw an increase in founder pitches for both new and copycat businesses. Others were later-stage investors, who found that while big rounds to more mature startups were still closing, their peers are showing a greater degree of caution, either through longer due diligence processes, lower valuations, and a desire to engage more investors. at all around.

It is understandable why uncertainty has crept into the market. Since the beginning of this year, the S&P 500 is down 16%, while the S&P 500 IT sector is down 23%.

Inflation has increased in many countries: the US by 8.5%, Australia by 5.1% and New Zealand by 6.9%. Central banks have moved to cool down their economies. The US Federal Reserve raised interest rates twice this year from a low of 0.25% to 1.00%.

The Reserve Bank of Australia recorded a single rise from 0.10% to 0.35% last week. Meanwhile, the Reserve Bank of New Zealand has raised its spot interest rate four times since October 2021, from 0.25% to 1.50% last month.

While higher inflation and tighter monetary policy, along with current geopolitical uncertainties, will impact the availability of capital in all markets, including venture capital, founders can still prepare to support their startups for success.

Reformulate valuation expectations

When things are moving at a rapid pace and there is strong competition to close a deal, valuations are rising, and when a startup speeds up post-funding and improves its trajectory, an even higher next-round valuation is assured.

In an uncertain environment, valuations are likely to come under pressure. Instead of raising money today at tomorrow’s valuation, founders are more likely to raise money today at today’s valuation. The difference between these two valuations depends on the stage and traction of the startup.

For founders (and investors) looking to avoid downturns, there will be a larger deal structure to maintain valuations.

Do more with less

Lower valuations lead to smaller rounds. If you do a bigger round at a lower valuation, founders and existing shareholders will experience too much dilution.

Founders will have to adjust their business plan accordingly. Instead of opening on multiple markets at the same time, they may need to open the markets one after the other. Focusing on one product line may be better than splitting energy between two.

Resist more control

Demonstrating product market suitability is often challenging, but those who do will be rewarded. Not only will they build a business that their customers will help pay for, but they will also be more attractive in the eyes of investors.

Product market adjustment measures vary based on a startup’s maturity. In the beginning, this could be pre-registrations, results of customer development conversations and letters of intent. Once the product is launched, it can be daily/weekly/monthly active users, number of actions per user and time spent on the site/application. As the product matures, this could include detailed case studies, NPS score, and churn rate.

Expect more control from your unit economy. Do the direct revenues and costs of a sales unit fall back? What is the relationship between customer acquisition cost and lifetime value? What is the gross profit margin? What is the average order value?

Founders with high performing measures of product market fit and robust unit economics will be rewarded.

Keep the balance

Cash is the lifeblood of any business. While we would all like cash inflows to exceed cash outflows, the opposite is true when startups are busy acquiring a product market fit and growing. Therefore, it is becoming increasingly important to manage a startup’s cash balance or available runway. Companies with larger runways have more time to prove their case than companies that don’t.

Difficult trade-offs will have to be made to maintain the balance. A decision to hire additional developers may be delayed. The rebranding can be suspended for a quarter. The timing for creating an additional product can be adjusted. Whatever the compromises, it will be critical to demonstrate progress over this period. One of the first questions an investor asks is how much money has been raised before? They want to understand your startup’s capital efficiency and what you’ve accomplished.

Building for the long term

While the next period may be uncertain, founders who build great companies need to be sure that there is capital to back them up.

Most VCs, especially those with an operator background, take a long-term view and recognize that business, like life, is a cycle. It may take several iterations to achieve sustained success, but the journey is worth it.

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