Seed in a Storm

Squeeze. Contraction. Pause. Wait-and-see. Foot off the gas. Negative sentiment.

We’re hearing a lot of that these days. We might be heading into a recession. Inflation is high. Supply chains remain strained. Interest rates are increasing. And of course, there is war in Europe.

After the frenzy of the last few years both up and down the venture capital spectrum, there are certainly numerous reasons right now for an ebb to this flow. And indeed, we know that tech IPOs have slowed down, which in turn has caused growth equity to pull back, and it seems even Series A and B are starting to feel the retraction. (See CB Insights, Q1’22 Report)

But not Seed (See Angellist State of U.S. Early-Stage Venture & Startups: 1Q22). And the question is: not yet or not ever?

Is Seed sheltered from the storm?

Some say that Seed is protected. There are arguments that Seed investing is somewhat safeguarded from macro events because of the small cheque sizes (which just don’t feel the pinch as much as $100M cheques) and because the companies in question are still 5–10 years out so it is nearly impossible to predict what the market will be like at their exits.

Y-Combinator certainly continues to party like its 2019 — perhaps more so. Are they right? I don’t know.

Or will Seed feel the whirlwind of the tempest too?

There is also a good argument to be made that Seed isn’t special and it will eventually feel the macro effects making their way down the maturity scale.

If Series A valuations get squeezed, then Seed investors may lower valuation expectations for Seed and Pre-seed (especially if the industry continues to use the ‘double your valuation with each raise’ math). Furthermore, if A rounds are harder and take longer to raise, then Seed investors might bake that into their valuation calculations.

Moreover, the increased probability of companies needing bridge rounds to get to their Series A milestones may also push down early valuations as Seed investors worry about needing to use more of their reserves to support promising portfolio companies. As an aside, this creates an interesting toggle on whether an inside round is viewed as a sign of strength or a sign of weaknesses. It has been both at different times over the past decade.

Ground Soil

But let’s cut to the chase: what is actually happening on the ground?

At StandUp Ventures, what we’re seeing in the Canadian ecosystem is that both Seed and Pre-seed remain healthy. There are many high-quality companies with incredible founders raising money. We have certainly had a very full pipeline so far in 2022!

Furthermore, investors at this stage continue to be hungry and hunt for great companies. There hasn’t been a tectonic shift in valuations.

But (yes, you knew a ‘but’ was coming) something is changing. A few hot companies — through FOMO and momentum — continue to raise at what I still consider to be mind-boggling multiples. But for the most part, multiples seem to be softening, slowly settling back down to less stratospheric levels. It is much harder now to raise at 30x your projected ARR 12 months out.

Why? The last few years have taught us that life is even more unpredictable than we thought. We now more fully appreciate that we don’t know what the world will look like in 12 months; the combination of inflation, supply chain issues, and rate hikes (to say nothing of a serious military conflict in Europe) could make financial projections, roadmaps, and plans mean even less than they ever did.

As early stage investors, we are also less certain about what companies will need to achieve to raise a Series A in 12–18 months, to what standards they will be held, and what terms may be offered.

Waving in the Wind

Here’s the thing. This isn’t actually all bad.

It feels like we’re coming in for a ‘soft landing’ after the last few high-flying years. Not a crash. Valuations aren’t tanking. People are still raising money for good companies.

There is a sense of the frenzy relaxing. It’s less frantic and chaotic. Quite frankly, it allows all of us (on both sides of the proverbial table) to take a look at the options and make better decisions that feel less under-the-gun.

I’ll tell you a secret: this is the nature of investing in a market. It goes up and it goes down. It becomes frenzied with FOMO, and then it retracts. But it never stops. There will always be brave folks starting exciting new companies and other brave folks willing to invest in them.

We are lucky at StandUp Ventures to be backed by incredible LPs — both institutional and individual — and have just started to invest out of our new fund. We remain laser-focused on investing in great founders building high-potential companies. We also work closely with our portfolio companies to help them think strategically about these market conditions.

I, for one, remain as excited as ever to be investing in and supporting early stage Canadian companies.