Tom Loverro: The Ultimate Startup Survival Guide for 2023 | 20VC #977

Market Context & Outlook:

• Public market multiples have corrected to 2016–2018 levels, signaling a return to historical norms for software companies.
• Private market valuations are aligning with public multiples, moving away from the irrational pricing of 2020–2021.
• The industry is transitioning from a "bubble" environment back to fundamentals-driven diligence, a shift expected to intensify in the second half of 2023.
• Venture and technology asset classes are projected to be larger in 10, 20, and 30 years, despite a near-term "hangover" from previous excesses.

Valuation Trends & Down Rounds:

• Down rounds are expected to occur this cycle due to the disconnect between 2021 inflated valuations and current fundamentals.
• Pricing for Series B/C deals in 2022 had already corrected to 10–15x forward ARR, similar to pre-COVID levels.
• While down rounds are complex and psychologically difficult for VCs, fewer will occur than market logic might suggest due to VC aversion to damaging balance sheets.
• Seed and Series A valuations are trending back toward 2011 levels, with early-stage prices remaining stable slightly longer than later-stage rounds.
• Companies raising at pre-product market fit valuations of 1,000x ARR face existential risks unless they achieve profitability or strategic pivots.

Fundraising Strategy for Founders:

• Founders should initiate fundraising processes when they have 12 months of runway remaining, aiming to close with 6–7 months left.
• Raising early is preferred to avoid "smelly fish" reputations associated with raising at the last minute or during a liquidity crunch.
• Founders should secure multiple term sheets by setting a 10-day deadline to create urgency and maximize leverage without appearing to "shop" deals.
• "Bridge rounds" lasting less than six months are generally considered "bridges to nowhere" and rarely succeed in providing a path to a subsequent raise.
• Companies with 18 months of runway should not raise immediately but must prepare to extend runway through cuts if market conditions deteriorate.

Operational Decisions & Cost Management:

• Companies should cut costs to extend runway but must continue funding core R&D to maintain product-market fit.
• Marketing spend becomes more efficient in downturns as competitors withdraw, lowering Customer Acquisition Costs (CAC).
• Founders are advised to "lean in" to growth opportunities like hiring top talent or bidding for keywords while competitors are pulling back.
• Trade-offs between immediate growth and economic efficiency are temporary; founders can pivot back to high growth once unit economics are refined.
• Hiring experienced C-level operators is critical during downturns as they can optimize spending faster than junior hires, often paying for their own salaries.

Investor Dynamics & Liquidity:

• Venture capital deployment cycles are shifting from 9–12 months back to a 2–3 year standard as Limited Partners (LPs) push back on rapid capital deployment.
• LPs are less willing to commit follow-on capital quickly, forcing General Partners (GPs) to conserve dry powder.
• Many VC firms have been slow to mark down their books, though investors argue markdowns are necessary to reflect current gravity on private assets.
• Secondary markets are expected to see increased volume during downturns when assets are overpriced, providing liquidity in a frozen primary market.
• "Pay-to-play" provisions are becoming a concern, where investors may face massive dilution if they do not participate in down rounds.

Founder Advice & Career Moves:

• Founders should prioritize survival over valuation sensitivity; securing capital is more important than maintaining a high pre-money valuation.
• Governance remains vital; founders cannot rely on "cheap capital" without board support when raising in difficult markets.
• Equity in companies joining post-2021 may remain underwater, but companies can use creative structures to incentivize employees and prevent flight.
• Venture career movement may slow as employees at large tech firms stay for safety, while venture firms face pressure due to reduced carry.
• Best investors are those who "get with the program" quickly, accepting that the market will not return to 2021 conditions.

Specific Predictions & Timeline:

• Deal flow is expected to spike in July and August 2023 as founders anticipate a surge of competitors launching fundraising campaigns around Labor Day.
• The current downturn is predicted to be worse than the Great Financial Crisis due to the extent of pre-revenue valuations reached in 2020–2021.
• A "calm before the storm" exists now, but a flood of companies will seek capital in the second half of the year, forcing investors to triage opportunities.

Personal Insights & Trends:

• Tom believes the meme that founders reject governance is dead; active board involvement is essential during crises.
• Tom's biggest investment mistake was failing to invest in Fivetran (George Frazier), missing out on hundreds of millions in gains.
• Tom identifies the "bias to action" and "trust your conviction" as the most valuable mentorship advice he received.
• Tom hopes to find more founders with high energy and execution ability, citing Brian Armstrong and Mitchell Arman as examples.
• Tom advocates for promoting junior talent faster and offering more carry to them to increase diversity and speed within VC firms.