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Venture capitalists who concentrate on supporting startups in their initial seed stage now generally assert that they have become more selective when it comes to choosing which startups they are willing to invest in. This is further evidence of how the slowdown in the venture capital industry is impacting companies that were once shielded from the volatile business landscape.
Emerging startups are now required to meet more stringent criteria, such as annual recurring revenue and customer acquisition, in order to appeal to investors. Investors also mention that they are scrutinizing a greater number of deals before making commitments.
A recent report from Forum Ventures, a venture firm specializing in pre-seed and seed-stage startups, has highlighted the increased scrutiny seed-focused investors are placing on startups. According to the report, founders seeking seed and Series A funding need to quickly demonstrate the market demand for their products or services. They should also set their sights on achieving an annual recurring revenue of at least $1.5 million, with a year-over-year revenue growth rate ranging from 100% to 200%.
The report noted that the expectations for pre-seed funding have evolved, now requiring startups to present evidence similar to what seed rounds required a few years ago. It emphasized that startups should place more emphasis on acquiring and retaining customers.
The co-founder and co-managing partner of Las Olas Venture Capital, which focuses on seed-stage investments, mentioned that his firm used to invest in startups without any revenue before the market downturn. However, he noted that in the current environment, no one in his network is pursuing such deals anymore; instead, there is a strong preference for startups that have demonstrated revenue traction.
He mentioned that when there's a slowdown in overall venture investment, the expectations for revenue and customer traction tend to be raised. He drew on his past experience when he was involved in launching a company during the dot-com bust of 2000 and 2001. He pointed out that unlike before 2000 when founders could secure funding based on business plans alone, they had to demonstrate tangible revenue growth during that challenging period.
The founder of Las Olas Venture Capital suggests that demanding more from seed-stage companies ultimately does not harm innovation. Elevated standards are typically a positive aspect. It can be argued that in times of readily available funding, a fear of missing out can drive investments into poorly planned businesses.
The data from the third quarter of this year indicates a slowdown in the rate at which venture investors are making deals with pre-seed and seed-stage startups. In the nine months leading up to the third quarter, the Venture Monitor report by analytics firm PitchBook Data and the National Venture Capital Association showed that the number of completed seed- and pre-seed deals remained relatively stable at around 1,200 per quarter. However, in the third quarter, the number of deals dropped to 820, marking the lowest quarterly level since at least 2013.
Entrepreneur Media, the company behind Entrepreneur magazine and Entrepreneur.com, announced last week the launch of Entrepreneur Ventures, a venture capital fund based in Los Angeles. This fund intends to allocate investments of up to $10 million to approximately 150 to 200 pre-seed stage startups operating in various sectors, including consumer and enterprise technology.
Jonathan Hung, who serves as a general partner at Entrepreneur Ventures, mentioned that he is emphasizing the importance of due diligence. Overall, investors are adopting a more comprehensive approach when evaluating investments, involving more thorough risk assessments.
Hung explained that since their fund primarily targets pre-seed startups, they are willing to consider both startups with and without revenue. While they certainly welcome investments in revenue-generating companies, revenue is not the sole criterion they take into account. Hung mentioned that the new fund aims to ensure that the startups it supports can withstand the current market conditions. He also advised early-stage startup founders to prepare for a potentially extended journey in raising capital.
In 2021, during the height of a robust market, Vimcal successfully raised $1.9 million in a pre-seed funding round, with no challenges in obtaining $25,000 investments. John Li, the co-founder and CEO of the calendar app, highlighted that during this period, a startup's story and reputation could sway investors effortlessly. Li also noted that Vimcal had already established both revenue and a customer base at that time.
Li explained that this year, when Vimcal secured a $4.5 million seed funding round, the dynamics had changed. Typically, the investment amounts were smaller, and investors placed greater emphasis on business metrics such as customer engagement and growth. The process also involved a heavier focus on numerical data.