How early-stage investors can navigate the most chaotic economy in living memory
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At the beginning of 2022, many early-stage investors looked ahead with optimism as we emerged from the depths of the COVID-19 pandemic, and global economies started to show signs of growth again.
If only we knew back then what was to come. Fast forward to Q4 of 2022, and the world is in the eye of the storm. Could we have ever imagined there would be war in Europe, double-digit inflation, and the NASDAQ falling 30%? To add insult to injury, in the UK, we’re currently experiencing a period of laughable political instability, churning through three Prime Ministers and their respective Chancellors in just six months.
2022 has been one of the most unpredictable and unstable years, both politically and economically, in living memory. As energy and food crises drove up inflation and interest rates soared, public markets crashed in response. Private markets followed soon after. Crossover investors fled while some VC firms pressed pause. This past summer was excruciating for many start-ups, and you could be forgiven for assuming the world of founding and investing in start-ups was to be avoided. There’s no doubt that things are difficult, so as we look ahead to 2023, is there a way for early-stage investors to navigate such a chaotic economy?
The fundamental questions VCs must ask
Being at a low ebb is always a time of opportunity. Founders who balance ambition with nimbleness and sustainability and who execute realistically will find that now is actually a better time than ever to grow a start-up. Experienced investors have continued to invest and, in fact, invested more in the second half than in the first half of 2022.
...now is actually a better time than ever to grow a start-up.
Returning to the basics is the best thing to do when staring down the chaos and confusion, and investors should again start asking the fundamental questions. You know, the ones they should have always known but have seemingly forgotten over the past few years.
Does the start-up have a product that solves a large, global problem right now and not at some theoretical time in the future? Are the business model and unit economics scalable? Do the founders have the necessary execution edge based on track record? Do the deal terms make sense for both founders and investors?
These are obvious questions, but driven by a crippling sense of FOMO as money flowed easily and markets rocketed upwards in recent years, many investors compromised on the answers. There are many high-profile examples of investors now paying the price. Early-stage investors need to be unflinching in their commitment to these questions and must walk away unless they get satisfactory answers.
Early-stage investors need to be unflinching in their commitment to these questions and must walk away unless they get satisfactory answers.
During the bull market of the previous few years, adrenaline ran high for both founders and investors. We saw start-ups partner with unsuitable investors, raising funding at unsustainable valuations, and venture capital firms investing in businesses ill-suited for the unique demands of venture capital. To my mind, as founders and investors reset during this low ebb, we’ll return to the best of venture capital: empowering start-ups that become the most category-defining, influential, and important companies of the next generation.
ESG is a must-have, not an option
During this period of macro challenges, founders and investors of start-ups must not lose sight of ESG (Environmental, Social, and Corporate Governance). In the investing world, a dangerous form of shortsightedness is creeping in, as ESG seems to be a separate investment category on its own. While emerging categories of investors specialising in impact, diversity, and net zero are very welcome, these ESG issues should be at the top of every early-stage founder and investor’s mind. Much like the set of questions previously mentioned, these concerns should form part of the bedrock of every investment decision.
It’s no coincidence that every successful start-up I’ve been involved in was underpinned by a values-driven mission. This has included lowering the cost of migrant remittances between countries, bringing public investors back into public markets, bringing cost transparency to asset management, ensuring no one’s unnecessarily excluded from opening a bank account and delivering affordable employer-provided health support not linked to seniority. These companies were successful because they addressed a universal and immediate problem and were driven by a mission to make a sustainable positive impact. With a clear focus on inclusion and fairness, these start-ups had successful exits, hired better, found better partners and raised capital faster. Do good, and you are much more likely to do well.
Do good, and you are much more likely to do well.
My unfiltered opinion
Undoubtedly, we’re in a very challenging climate. The word ‘unprecedented’ has been overused since early 2020, but it’s still perfectly apt to describe the situation we’re in now. For those companies that have found success during these past few years, the chaos they’ve navigated is a testament to their resilience and the strength of the fundamentals underpinning their businesses.
Of course, we all want economies to grow, inflation to decrease, and the cost-of-living crisis to be put behind us before we feel truly confident about the future. At the same time, however, now is an excellent moment for early-stage investors to get back to the basics, make good investment decisions and empower the companies of the future. Get it right, and the payback will be more than worth the risk.