European VC dealmaking failed to break through the €100 billion mark in 2022 as it had the previous year. While the estimated 12,000 deals still represented the second-highest year on record by a fair margin, the economic headwinds in the second half of the year changed the landscape for startups looking to build and scale their companies. That roughly $400 billion (€375 billion) of value from European tech companies was erased across both public and private markets in just 12 months was one of the sobering facts in Atomico’s annual State of European Tech report. It’s clear that the cash is not flowing as freely as it once was.
The search for fresh funding in the midst of a challenging economic climate doesn’t mean that startups need to settle for lower valuations, accept the first offer on the table, or bring on board investors that have different values for the business. In fact, it is important that every party approaches the negotiating table with clear questions and expectations.
When it comes to speaking with potential investors, these are firm but fair questions that as a VC I think should be asked.
How stable is your fund?
The effects of this economic cool-down are not just confined to fast-growth tech companies. It’s inevitable that some VCs will also wind down as they fail to raise a subsequent fund. It always surprises me how many founders believe VCs are sitting on piles of cash that they are ready to distribute at any moment. It should be remembered that VCs don’t have an endless pot of money – they are at the mercy of their LPs’ liquidity. It is therefore sensible for startups to understand how secure any potential funds are. Tied to that it should be clear whether they will be in a financial position to continue supporting the company along its growth path, and what, if any, proportion of the funds are put aside for follow-on opportunities.
Just as an investor runs due diligence on a startup, founders shouldn’t be afraid to reciprocate and gather as much information as possible about financial readiness and the security of the investor’s funds.
Apart from money what value can you provide?
An investor that isn’t able to demonstrate their value beyond deep pockets should be an instant red flag. Being able to make meaningful connections with individuals or companies that are relevant to your growth plans is a simple yet demonstrable form of value. Many investors pride themselves on their contact book, but not all introductions are the same.
My advice is to be clear about your commercial goals and push potential investors to offer the names of individuals or organisations that will deliver the impact you’re looking for. There is likely a big difference in the type of network and strategic opportunities that a generalist VC can offer versus a niche or sector-specific investor. Startups should feel confident about interrogating the strength and depth of their network beyond just names and scope out what relationships can be leveraged to deliver tangible commercial benefits.
Do you have rigid exit plans?
With many startups still raising capital every 12-18 months, founders need to make sure that any potential investors are aligned with their growth plans, especially when it comes to exit scenarios. Investors that duck out after 18 months can not only be disruptive for a growing business, particularly in cases where investors join the board, but it can also be a warning sign for new investors who may wonder why they are not sticking around.
Startups should be valuing the support of investors beyond the immediate first-time cash injection. In some cases there could be a ten-year relationship between founders and investors before they exit, and, while it might seem frivolous, the partnerships that deliver the most happen when people like each other.
If your preferred investors do have a firm exit timeline, it’s worth asking whether they have growth vehicles to support startups after the early-stage fund. Where possible, try and ensure that growth plans match from the outset to avoid an investor liquidating their position early.
Know your worth
Despite a tough economic climate and investment firms with dry powder aplenty, it doesn’t mean the power dynamic automatically tips in favour of those with the cash. If as a founder you feel like you are being squeezed and undervalued by potential investors, you need to assess whether this is the right relationship for you. The best working relationships are the ones that are built on an equitable footing with honesty and clarity.
My biggest piece of advice to founders is to know your worth – be bold in your due diligence and pursue the investors that will be mutually beneficial. There is more to an investment than just cash and you shouldn’t have to settle for anything less that feels like real value.
Talia Rafaeli is a General Partner at Kompas focusing on investing in the startups that will lead the digital transformation and sustainability revolutions in major industrial verticals. We look to back ambitious founders who develop technology to transform buildings into more sustainable and healthy spaces, reduce the environmental impact of the construction and manufacturing industries, and transform the way modern organisations work.
Lead image: Jordan Madrid