The year 2022 has been devastating to startup funding and valuations.
Following the bubble of 2021, series A funding was already down 20% in the year’s first half. This trend has worsened further, with Q3 seeing a 37% decline in VC funding from the previous quarter and 53% from 2021.
Ongoing increased inflation isn’t helping matters either, causing the Federal Reserve to increase rates exponentially.
“The rate hikes are having a catastrophic impact on the tech markets, which are valued on long-dated future cash flows as discount rates increase,” said Don Muir, Co-Founder, and CEO of Arc Technologies.
He explained that while debt had become expensive in the environment, the higher rates had caused valuations to plummet. “All the big software companies are down 50%, sometimes up to 80% or 90%. That’s now bled through the private markets. And we’re seeing that either VCs aren’t investing, or startups do not want to raise because valuations are so low.”
The high expense of equity for startups has caused them to look elsewhere for funding.
“While interest rates are up 4%, making debt more expensive, equity has become 10 times more expensive, which makes non-dilutive capital 10 times more attractive…(This) has caused more startups to consider alternative sources of financing.”
The void of VC
Arc offers alternative funding to early-stage startups, increasing capital without dilution, and other solutions for assisting the growth of start-ups.
“In a high growth early-stage company, it’s burning cash. That’s when capital is the most expensive because you’re growing quickly,” said Muir. “When you sell $1 of equity, that dollar becomes infinitely more valuable years down the road, as the revenue grows as the business becomes larger”.
“The Arc Advance product converts those future revenue streams into upfront capital without dilution.”
As explained by Muir, investment in high-growth early-stage startups can be a lucrative business. Companies invest when valuations are low, providing essential capital to push startups to grow, hoping for significant returns.
2021 saw a rush of investment from all angles in early-stage tech. Stories of double-digit returns from tech startups that had quickly “gone to the moon” became commonplace. Now that valuations have plummeted, tech startup “deals” are harder to come by.
“There’s been a huge shift in mindset from VCs,” said Muir. “It’s unfortunate to see so many companies coming to Arc where the rug was pulled out from underneath their business. The VCs on their cap table, they expected them to be there for the long term to reinvest through a cycle that hasn’t happened in many cases.”
Muir explained that in the bubble of 2021, startups were encouraged to “grow at all costs.” This involved hiring an extensive workforce and investing in all areas of the business ahead of increased revenue streams for companies to grow fast.
“All of a sudden, inflation happens. A switch is flipped, and rising rates just cause all of that investor sentiment to go away and “grow at all costs” is suddenly replaced with, “profitability, unit economics, cash flow.” These businesses that were encouraged by their VCs and their boards to grow at all costs, with a bloated operating structure, now need to lay off 50% of their team to achieve positive unit economics .”
“They were really encouraged by their venture capital investors by their board members who top VCs back to grow at all cost, and the goalposts were suddenly moved just months later.”
Funding growth
While VCs have cooled off, early-stage startups continue to need investment, and the sector is in dire need of alternative solutions.
It is here technology could have the upper hand.
Arc has developed a system to provide capital upfront for startups by focusing on “strong business fundamentals.”
“The secret sauce is the technology we’ve built,” said Muir. “Unlike banks, venture debt, credit funds, and venture capital firms, we leverage the modern finance stack to make faster and better underwriting decisions.”
He explained that Arc looks for premium, revenue-generating businesses that can be provided upfront capital for future revenue flows. The sector that most fits this bill is B2B SaaS, which has the most consistent, recurring revenue streams.
Arc looks to grow with the early-stage start-ups they get involved with, using their technology to adjust according to their needs and wean them off a dependency on VC funding.
“Under NDA, we maintain access to our customers’ financials, and we can upsize them as they grow. We can monitor their performance as they grow and push through, you know, cost savings to the extent the business improves, or increase their credit limit if the business continues to grow.”
“That dynamic relationship is much better built for early stage high growth businesses, that is dynamic and is constantly evolving.”
The company maintains that despite the drop in funding for start-ups, it’s more a question of returning to conservative growth seen in previous years rather than the “doom and gloom” of an economic downturn.
“The strategy of “growth at any cost” works until it doesn’t,” wrote Head of Finance Annie Zhu in a blog post on Arc’s website. “Startups that built their businesses on top of cheap cash and unsustainable unit-economics, saw their valuations come down to earth… there’s still plenty of opportunities for startups to succeed.”
