Where the current venture environment leaves founders
It’s obvious by now that a perfect storm of world events, industry-specific developments and macroeconomics has dealt the sharpest financial blow to tech companies since the dot-com collapse. But while everyone is busy trying to figure out when stocks will bounce back (or which ones), the venture community has been talking about the impact on start-up investors and founders. Observers have pointed out a slow-down in VC funding, but it’s not yet entirely clear whether this is trickling down to the seed stage, and, more importantly, if this is discouraging founders from pursuing their ventures at all. A ‘start-up slowdown’ did happen during the Great Recession: a review from the Cleveland Fed found somewhat unequivocally that this was a time of entrepreneurial decline, at least in the US. This is not 2008, or even 2001, but evidence that the “Great Reshuffle” is coming to an end and people are settling back into corporate jobs (at least those who are not being laid off) would suggest we have reason to be pessimistic in short-term entrepreneurial activity.
Though it’s become almost cliché, Silicon Valley evangelists are quick to point out that tough times are also times of opportunity: the Airbnbs, Ubers, Venmos of the world were founded in its wake (see: Sequoia). The argument, of course, goes, that hard times created the right conditions for the sharing economy to find a market. The question then becomes, what is that next big opportunity? One could argue that we emerged from the rubble of 2001 and 2008 not through sheer scrappy innovation, but that the tech economy rode the waves of web and mobile adoption respectively. Perhaps more so than at any point in the last 30 years of tech, that “next big thing” is still a big question mark. To add to this unclear landscape, the 2022 contraction is not just financial, but is accompanied by real economic challenges, like privacy, supply chain, and energy costs, so the game has changed fundamentally for many founders in SaaS, ecommerce or crypto.
The next order question becomes, where do founders go from here in terms of industry, market and product? At a glance, fresh analysis from Crunchbase suggests that “metaverse” and “crypto” have remained surprisingly resilient. Intuitively, this feels off, given the focus on present cash flow – is it simply a lag in the data, or do we have further to go until early-stage bets feel the crunch? Perhaps zooming out and taking a broader look at how funding timelines impact founder decision-making over the long-term provides some insight. While academia is not often on the front-lines of venture analysis, I had the opportunity to write what amounted to a brief literature review on the subject late last year. In it, I try to understand what the current research says about whether, and how, financial determinants influence entrepreneurs’ choice of which industry to enter. Summarizing what we think we know and what it means:
How early in the process investors are willing to take risks on founders and ideas matters. Without making a qualitative judgment on whether funding pie-in-the-sky bets is a good or bad thing, the evidence shows that the “shape” of stage funding is more than just a financial exercise: it actually influences how founders make decisions.
For example, there is a gatekeeping effect: when capital is tight, it becomes harder for capital-intensive industries to attract investment for new ventures. Entrepreneurs are locked out of industries like healthcare, manufacturing, energy and transportation, while those in software and media can more often find ways to bootstrap.
There is also a meaningful “choice effect”: it’s not just about where capital flows, but also where talented and motivated entrepreneurs choose to go, industry-wise. Investors and founders are people, whose decisions are embedded in entrepreneurial ecosystems and influenced by opinions from investors, advisors, etc.
There are interesting regional differences with tie-ins to broader macroeconomic policy and cultural differences. Experienced investors and founders reading this will likely already know that the start-up landscape in the US is significantly different to those of Europe and China. Socio-cultural factors, such as appetite for risk, individual vs. collectivist values and views on the role of government all play a role in what industries are accessible to which founders.
So taken together, what does this all mean? Most likely, similarly to 2001 and 2008, more founders will stay out of the market than would have if capital were more readily available. Those who stay may feel more pressure to turn to tried-and-true technologies. Building for “the next big thing” feels riskier than it did for web 2.0 or mobile, because everyone already knew those things would be big – not yet so for crypto, the metaverse or web3. To be clear, I don’t think availability of funding is the only, or even most significant factor, but given the current accordion-style contraction in VC with a tech future that is perhaps more a mystery than ever before, the question of whether capital remains accessible at the early stages is perhaps more important than ever.
One final and related speculation is that this will be a time to retry old ideas. Start-up observers have pointed out that many of the most successful products are second, third or fourth iterations of past attempts – perhaps even more than are brand new. Marc Andreesen articulated this well: invention can often be about timing. Will there be a version of a past product, or a current sleeper start-up, that finds product-market fit in whatever new environment we are heading into? I would say let’s hope so, because founders need all of the optimism they can get.
