How VC Funding Is Changing In 2023 - And What This Means For The SaaS Industry
It’s becoming increasingly clear that 2023 will be a challenging year for many businesses.
With a global recession looming and finances being strained, the tech industry is already feeling the impact. Companies are grappling with rising layoffs and hiring freezes, consumers are dealing with a cost-of-living crisis, and venture capital firms are being more selective with their investments.
Statistics suggest that many SaaS businesses may struggle to secure venture capital funding in this climate. Total global VC funding dropped 33% quarter-over-quarter in Q3 2022, while SaaS-specific valuations have steadily declined since the beginning of 2022.
Not only will tech start-ups need to overcome wider economic challenges, but they’ll also need to find a way to survive a decrease in funding opportunities.
However, for anyone operating in the SaaS industry, this is a good time to reflect on the reality of the situation - and more importantly, avoid panicking.
While there’s no question that the economic climate and business landscape will be turbulent this year, this doesn’t necessarily spell disaster for every tech start-up. In fact, SaaS businesses that can weather the storm may find themselves in a strong position to expand once the market settles down.
Many start-ups will just need to re-think their growth strategy and re-focus their priorities in order to thrive in the long run.
Let’s explore how the venture capital funding world is changing in 2023, and what this means for the long-term prospects of the SaaS industry.
How is the venture capital funding landscape changing?
The tech industry has experienced jaw-dropping levels of growth in recent years, with future-facing brands constantly emerging to deliver innovative products and services.
This surge in new start-up businesses was fuelled by investment from venture capitalists - investments in tech ventures almost doubled during Q1 of 2021, and tech start-ups accounted for nearly 70% of total venture investments in the same quarter.
But this ‘tech boom’ is now coming to an end - or at least a prolonged pause.
Venture capital funding has been steadily dwindling since 2022, and the criteria for investment are changing. Profitability is now more important than growth for many VC firms, which need to see consistent and tangible returns on their investments.
Start-up founders will face a higher barrier to entry for venture capital funding, and may also need to give up more of their equity in order to successfully close funding rounds. While more established SaaS businesses will be in a better position to secure VC funding, many early-stage start-ups could find themselves needing to pursue other financing options.
However, it’s not all bad news for early-stage tech businesses. While VC funding will undoubtedly become more difficult to access, there are still funds looking to invest in early-stage start-ups while the market steadies itself - in the US, for example, H1 2022 was the most active half in history in terms of seed deals, with 2,900+ deals closed.
To adapt to this changing market, tech businesses are now being forced to prioritise their core business offering and ruthlessly cut down on expenses. Many companies are also seeking non-equity financing - including some that have just raised equity capital.
How can the SaaS industry respond to these changes?
If SaaS start-ups want to continue accelerating growth and scaling up their business, they’ll need to shift their focus to a different set of metrics when pitching for investment.
While promising growth signals may previously have been enough to attract investors, the criteria for VC funding are now more stringent. SaaS companies will need to display metrics revolving around efficiency and profitability, such as:
Gross retention (with a goal of around 90%)
Net retention (with a goal of around 110%)
Gross margins (with a goal of around 75%)
Customer Acquisition Cost (CAC) (with a payback goal of <2 years)
Tech companies struggling to achieve these metrics will need to re-calibrate their business strategy if they want to access funding.
This isn’t just vital for short-term investment, either - it may also prove to be incredibly important for long-term growth. Businesses that can maintain strong efficiency metrics will be highly appealing for VC funds as the market stabilises, since investors will inevitably be searching for quality prospects when the situation improves.
Start-ups that can balance solid fundamentals, positive efficiency metrics, and healthy growth rates will be well-equipped to weather the current storm and capitalise on renewed investment on the other side.
It will also be extremely important for SaaS innovators to continue doing what they do best - innovating.
Companies may be tempted to write off 2023 as a financial dead-end, but that doesn’t need to be the case. Start-ups can use this opportunity to identify areas for product innovation and set themselves up for future success - for example, by creating dedicated innovation teams, reallocating internal resources, or establishing accelerator programs.
Above all else, SaaS businesses need to recognise that priorities are shifting for VC funds in a tough economic climate. Securing investment is now about proving the longevity, reliability, and sustainability of company growth - not selling an exciting idea or promising concept.
Metrics like cash flow, runway, and EBITDA are now the most important for potential investors. The faster tech start-ups acknowledge this and adapt their business strategy, the more likely they’ll be to achieve growth.
2023 will be a difficult year for the tech industry, but that doesn’t mean start-ups can’t adjust their strategies to survive the economic turbulence - and more importantly, thrive once the market improves.
While limited venture capitalist funding may consolidate the market, the companies that emerge from this downturn will be much better prepared to drive sustainable growth and scale up their offering. Many of these start-ups may even become unicorns further down the line, so it’s a case of overcoming short-term challenges to ensure long-term success.
If your company lies within the Tech or SaaS space and you’re keen to build out your finance team, don’t hesitate to get in touch with Thomas ([email protected]) for expert support.
