[PitchBook] After being largely unaffected by the pressure that market turmoil has put on larger tech companies, early-stage startups are beginning to feel the chill.
Changes in the market climate often come quickly, but those trends can take awhile to show up in a comprehensive dataset. But deal-by-deal, anecdotal evidence gives investors a good sense of which way the winds are blowing.
As a limited partner in close contact with seed-stage VCs, Michael Kim has an especially clear window into the early-stage venture capital market. His firm, Cendana Capital, is a fund-of-funds that backs dozens of seed firms, including Lerer Hippeau, Susa Ventures, Freestyle Capital and Uncork VC. Kim also regularly checks in with Series A-focused funds about their financing requirements.
His takeaway is that VCs have recently adopted a distinctly more conservative approach to early-stage deals.
Over the last two or three months, seed and Series A deal valuations have dropped significantly, and early-stage investors have gotten more selective, focusing on startups that can meet more substantial revenue targets than were required in the past.
Last year, the typical best-in-class Series A deal was raising around $20 million at a post-money valuation of $120 million, according to Kim. But recently those round sizes and valuations have tumbled to about $10 million and $50 million, respectively, he said. As a result, founders are accepting increased dilution of the stakes they hold in their own companies.
In addition to lowering valuations, some investors are putting a sharper focus on revenue growth. Kim said that some VC firms, including Sequoia, are starting to demand that companies demonstrate more robust revenue before seeking a Series A. A spokesperson for Sequoia declined to comment.
Over the last three to four years, the minimum for raising a Series A was about $1 million in annual recurring revenue. But that bar has now moved up to between $1.5 million and $2 million in ARR, Kim said.
"A company can't just show that [revenue] overnight," he said.
That suggests that seed-stage startups will need more time and capital to reach their next round of financing.
Some of these companies are now starting to raise seed extension rounds, which help tide them over until they raise a Series A, Kim said. An extension is a small financing done at the previous round's price and terms.
The seed stage is also seeing valuations fall significantly, he said.
"One of our fund managers was looking at a seed round for a Mexican company, and they wanted to raise $4 million on like a $25 million [pre-money] valuation," Kim said. "Realistically, that will probably happen at a $12 million [pre-money] valuation."
One exception to the trend is Web3 and other crypto-related seed deals.
Although the value of coins and shares of crypto companies like Coinbase have plummeted recently, Kim said he expects investors to continue to pile into early-stage Web3 projects. Some investors may be encouraged by the fact that crypto assets have rebounded from past downturns.
"The last crypto winter was in 2018," Kim said. "If you were making investments throughout 2018, you actually did really well."