Entrepreneurs must pay attention to what’s on investors’ minds

The writer is an investor in technology start-ups at Samos Investments

I’ve never had so many conversations around what investors are thinking as I am now.

And these discussions go right to the top of the investment cycle with limited partners (LPs) — the pension funds, insurance companies, endowments, foundations and high-net-worth individuals who, drawn by the traditionally high returns of the asset class, put large sums of money to work by funding venture capitalists.

This might seem too far up the food chain for start-up founders, but it is something they must pay attention to. How LPs react affects investors’ strategies. This, in turn, affects the ability of start-ups to fundraise and ensure the business has sufficient support through tough times.

One only has to look at the agenda for SuperReturn International, a large venture capital and private equity event, to see what topics are on the minds of LPs and investors. Environmental, social and governance issues, geopolitics, macro economics, general partner allocations and more are all talking points.

Indeed, VC funds face tricky economic times. Typically, a fund will deploy its capital within five years. Recently, however, there has been a spike in valuations. Companies are more expensive and funds are paying more to invest in them, leaving them burning through cash and needing to fundraise from LPs sooner than usual. Newer funds have returned to LPs to raise capital in as little as two years.

“As an emerging fund, market uncertainty hurts us the most during a capital raise — though stats show emerging managers, especially women, are outperforming,” says Gayatri Sarkar, founder of Advaita Capital. “We have seen in the past few years that if you are not disciplined and patient . . . having a large amount of money to throw at founders does not help the ecosystem, rather it brings it down.”

And VCs must navigate this difficult cycle while managing their portfolios. With rising costs, supply chain challenges and general uncertainty, many companies are in talks about business continuity. Conversations with investors tend to be around extending a bridge until things calm down — a difficult ask in the midst of a pandemic and with the war in Ukraine.

For founders, timing is everything and knowing which investors will be your lifeline when things get tough is critical. You need to make sure there is enough money — and support — around the table for when things aren’t going so well. (Interestingly, investors need the same thing: without supportive LPs who are willing to talk through their challenges and strategies, it is difficult for them to plan future fundraising.)

When in talks with investors, founders need to get a picture of a VC’s commitments and reserves to ensure they won’t run out of cash. Questions to ask include: how they think about the current economic and political climate — will they deploy capital in the immediate term? Who are their LPs? How are they thinking about follow-on investments in their portfolio companies?

At a time when every investor will be thinking about how to future proof their portfolio, founders also need to demonstrate how the business will make the money stretch. The best companies will get funded even in times of economic uncertainty. But investors also increase their due diligence so businesses that might have received cash in better times could face rejection. The more you can show efficient use of cash, the more likely you will be able to raise money and survive.

“I do not have the luxury of hindsight or historic data on companies when we invest,” says Yana Abramova, managing partner at Pretiosum Ventures, a VC fund. “What I do have, though, is the opportunity every time I invest to change an entire product category, industry or technology”.

I am cautiously optimistic. Much like when the pandemic first started, there will be more check-in calls with my portfolio founders. I want to understand their cash flow positions and plans for the best- and worst-case scenarios. For example, how important is their product or service for customers and, if inflation suddenly rocketed further, how likely are they to keep paying for it? I also want to know what the options for funding the business would be if potential investors were to panic and adopt a more cautious strategy.

If you’re a founder currently raising your first round of capital, you’re probably concerned about how quickly you will be able to complete. I would advise to proceed as normal — there is plenty of capital in the market — but ask the right questions and make sure you raise enough to get you through the next 18 months.