• Zahra Alubudi, COO & Co-Founder at Levenue


• 11.01.2024 10:45 am
#startup #investing

2023 proved to be a difficult year for many European startups financially. Forecasts show that funding for European tech companies will fall by nearly half, with just $45bn predicted to be raised compared to $82bn in 2022. Many founders are finding themselves closing in fast on the end of their runway and facing a difficult start in the new year. Survival, rather than growth will be topping many New Year’s wish lists.

Shifting priorities for investors

The decreased availability of venture capital in 2023 marked a significant shift from previous years of more generous valuations and abundant funding. Indeed, the funding environment of 2021 will feel like a long time ago for many investors and founders alike, with venture investment reaching a massive $621bn, a 111% increase in 2022. In this climate, the focus was on growth at all costs, because the financial backing was there to support it and embolden ambitious founders.

In 2023, we saw a marked shift towards move towards more sustainable financing models, with VCs becoming increasingly cautious and focusing on realistic business valuations and growth trajectories. This trend is likely to remain as such in 2024, with the VC funding slowdown predicted to continue amid persistent difficulties in raising funds.

Challenges at the End of the Runway

What this means for many startups is that they are nearing the end of their runway. It is notoriously hard to secure equity investment as a company reaches the end of its runway. Startups often face the dilemma of accepting unfavorable terms, including lower valuations, which can lead to substantial equity loss. Even bridge rounds, which have increased in prevalence in 2023 to offer immediate financial relief, often come with drawbacks. Not only does it further dilute the founders’ stake in the business, but it can signal financial instability to the market, in turn affecting future valuations and negotiations.

Founders therefore have to balance the immediate capital needs against long-term implications for the company's equity and control. And where possible, most will look at what changes they can make to their existing operations that will buy them more time. Primarily it requires them to pivot the organisation away from a high-growth model towards profitability and sustainability. This often involves significant business model adjustments, including cost reduction and strategic realignments. A bootstrap mentality becomes crucial, emphasizing efficient resource utilization and alternative financing methods to extend the runway and achieve sustainable growth.

However, the risk is that many businesses will enter short-term survival mode, letting growth fall by the wayside. This presents longer-term risks to the business. Not only because they will not achieve the growth levels that might be expected to raise future rounds at higher valuations, but because a lack of focus on innovation and growth risks competitors taking a greater share of the market.

This doesn’t have to be the case. By looking into alternative funding options, founders can continue to fuel their growth without taking on additional equity investment that will dilute their shares and risk reducing the company’s value.

Revenue-Based Financing: A Boom for SaaS Businesses

For SaaS and subscription-based businesses, revenue-based financing has emerged as a highly valuable alternative to equity investment. Aligned with their recurring revenue model, founders can trade their annual recurring revenue (ARR) for non-dilutive financing. With trading limits based on historical data and expected ARR, it is a more sustainable financing model and allows companies to increase their leverage potential as the company grows.

Indeed, this financing model is particularly effective for long-term growth investments as it enables companies to reinvest their revenues in key growth areas. For startups with predictable revenue streams, this can be an invaluable tool to support the continued pursuit of growth, while enabling founders to retain full ownership and control.

There are other alternative financing options, each with its benefits and risks. These include venture debt, which allows startups to leverage against their existing equity. However, this can be a more expensive and arduous process when liquidity is already diminished and companies are at the end of their runway. Crowdfunding is another avenue, that can also support startups in building a new or engaging an existing customer base, but it doesn’t come without its risks. It is a time-intensive process and companies may not meet their goals at the end of it and, in turn, not secure the necessary funds. And of course, this route once again requires founders to give up equity in their company.

Balancing risk, reward, and ownership

In the face of economic challenges, founders mustn’t focus on short-term survival at the long-term cost of their business. The need to continue focusing on innovation and building impactful solutions in this market is greater when buyers – B2B and consumer alike – are more discerning and, in many instances, more hesitant. It's crucial to maintain momentum and adapt to the evolving financing landscape, exploring the options that will help them pursue both growth and sustainability.

When deciding on the best avenue, founders must weigh up their startup's specific needs and the overall growth strategy, not to mention how much they are willing to give up. Balancing risk, reward, and ownership will be key to making the right alternative financing decision for their startup.