Ask Georges: Funding during bear markets, by the numbers

By Marc Weill, Villi Iltchev, and Vinay Iyengar on June 9, 2022

Many founders wading through this moment of uncertainty struggle to sift myth from reality in understanding what this market downturn is likely to mean for their business.

Georges Doribot, our AI team member and proprietary research tool that helps our team find new, innovative startups to back, is on hand to help answer our community’s most pressing questions about the current market downturn, with the goal of empowering founders to make data-informed decisions. In response to your questions, over the next few months, Two Sigma Ventures’ team members will share their input on how best to weather market headwinds, backed by data and historical context generated through Georges.

First up, we spotlight startup funding trends in previous bear markets (the dotcom bubble burst in 2001 and the 2008 financial crisis) to help extract insight into our current environment and how the size and pace of funding may take shape over the coming years.

Myth: “It will be nearly impossible for companies to receive funding during a bear market.”

Source: TSV Analysis of software companies, Crunchbase Data

Like the dotcom bubble burst in 2001, fueled by investments in Internet-based companies during the bull market in the late 1990s, recent years saw exponential and unsustainable growth in the value of equity markets. 2022 reached new highs–with the median deal size for series C reaching $71.5M, up nearly threefold from 2000 highs before the internet bubble burst, and up 119% since 2019. Now we’re faced with the risk of a tighter future fundraising market.

Throughout the span of the dotcom bubble burst (2000-2002), our data shows that median deal size fell by one-third (from $12M to $8M) and that during the Great Recession (2007-2009), median deal size fell by half (from $6M to $3M). However, despite an expected drop in deal size, it is still very possible for companies to receive funding during a bear market.

As we see in the data, deal activity in initial months of a bear market has tended to perform in what may appear to be a counterintuitive way. Activity drives up because buyers haven’t yet adjusted their valuation metrics to market realities, until over time, as reality sets in, the spread widens between what the CEO wants and what the VC is willing to give. Over time, as panic settles and more data becomes available around how inflation, the economy and employment are taking shape, founders’ and investors’ expectations inch closer and closer, and the market can reach balance.

In bear markets, amid the rise of cost and scarcity of capital, we expect to see a strong preference towards companies with clear product-market-fit and strong unit economics, rather than rewarding companies who pursue growth at all costs. As a result, we expect growth stage (think series C) companies to fare best, while pre-product-market-fit companies (likely at the seed stage) will face the most volatility.

While we can expect deal sizes and valuations to drop across the board, for great founders, this should not be a deterrent to building a world-class business. Funding will be available, but the metrics and criteria investors use to evaluate businesses may shift. Whereas in the past, investors were very focused on growth, today, investors will be more concerned about capital-efficiency. Metrics like the SaaS magic number (the ratio of net new ARR to sales and marketing spend in a given time period) and burn multiple (the ratio of net new ARR to net burn in a given time period) need to be measured, tracked, and controlled carefully.

Reality: “The pace of funding slows down in downturns.”

Source: TSV Analysis of software companies, Crunchbase Data

While it is still too soon to determine the median time we are going to wait between rounds in our present moment, we believe reflecting on previous bear market patterns for software companies provides us with key learnings. Founders need to control burn and ensure they have a lot of runway, ideally 24-36 months. We don’t know how long this downturn will last or how much worse it will get, so we encourage founders to be disciplined about how they spend money.

For a pre-product-market-fit company, likely at the seed stage, founders need to be as disciplined as possible. Focus only on product development and try to get your customers to fund your growth as much as possible .

For a post-PMF company (think series A/B/C), capital efficient growth should be the main priority. We encourage founders to experiment widely with various go-to-market strategies, measure things like CaC payback carefully, and invest a lot of capital into growth only once you’ve figured out the strategies that really work.  Continue to focus on ways to optimize CaC while exploring ways to increase customer LTV and prepare for the next chapter of your story.

Please don’t hesitate to come to us with any questions that Georges and the team can help you answer to power more informed decision-making.

The views expressed herein are solely the views of the author(s), are as of the date they were originally posted, and are not necessarily the views of Two Sigma Ventures, LP or any of its affiliates. They are not intended to provide, and should not be relied upon for, investment advice. Your linking to or use of any third-party websites is at your own risk. Two Sigma Ventures disclaims any responsibility for the products or services offered or the information contained on any third-party websites.