Three Biggest Risks in Early Stage Investing in 2022
Over the last couple of years, VCs were piled onto each other to throw money at mediocre companies with inflated valuations. I reflect on the risks of early-stage investing in 2022 as I see the falling knife of public tech stocks. I have come up with three risk factors that I need to feel comfortable with before investing.
1) Viability risk: Can this company be default alive with an absence of investor financing. In other words, does it have a revenue, margin, and retention base to get close to cash flow break-even at the end of my investment runway?
2) Valuation Risk: VC still does not agree on how to price earlier rounds due to late-stage and public markets multiples being depressed. I need to make sure that ownership is meaningful enough to combat multiple compression.
3) Customer Viability: Does your software or service serve a customer base that will have a contraction in a recessionary environment? Historical retention metrics need to be seriously tested with assumptions on market pullbacks.
It is a new world out there, and this is my new playbook.
Great post @david! I really resonate w 1 and 3 here. So often startups could likely, sometimes easily, get to profitability and then still provide a substantial ROI for early investors but are forced by many "unicorn" or "ring the Nasdaq bell" hunter VCs to show the path to unicorn to get the investment. I think the best scenario, as you might imagine, is to be in a place where the company CAN get to profitability and hence sustainability, but in the right environment could have a huge PE payout or even "ring the bell". Re #3, VCs and Angels should be on the lookout for companies who have a core customer base that is tied to what we learned in the pandemic to be "essential businesses". B2B companies that support infrastructure etc vs. B2C companies with discretionary funds being used are far more stable in uncertain times. That B2C, discretionary spending is what can drop like a rock or at best rubber band back and forth. My guess is that #2 you mention gets tied to where everyone agrees the markets and multiples will likely be when the company gets to scale and is ready for a potential exit. Assuming that is 3-4yrs out ones opinion on the economy rebounding becomes the basis for discussion I would assume. Thanks for great post