There’s no question that the sentiment of the venture capital market has shifted drastically over the past 12-18 months. Fundraising is never easy, but having been through a record-breaking period in 2020-21, it’s important for founders to recognise and understand “the new normal”.

It’s also useful to recap what VCs are looking for, how their decision-making process works and what may have changed since your last funding round.

So what’s going on in the market?

Deal volume is down. Later-stage growth funding is experiencing a freeze, with a big pricing disconnect that cascades from the public markets where valuation multiples have collapsed, especially for loss-making businesses. Overall, there’s a lack of alignment between VCs’ and founders’ expectations (and the valuations of their previous round versus today’s multiples).

As a result, VCs are slowing down their investment activity, and focusing on their core investment areas. Fewer off-strategy deals are happening, and many VCs spend more time in their home geographies.

However, money is still available for Series A funding, with many significant funds raised in the past couple of years and VCs (including us!) actively seeking investment opportunities.

Valuations are indeed lower, with early-stage VCs trying to square the economic gravitational forces of the later-stage market with the reality that it’s still expensive to grow a company, meaning that round sizes can’t easily come down, and dilution is a sensitive factor. Because of this valuation disconnect, some seed investors advise founders against fundraising now - a bet on a fast market rebound. My view is that lower valuations will persist for now, at least into the second half of next year. More companies will come out to raise in September and then a lot more in January, so we will find out soon enough.

Despite these challenges, start-ups can still raise new funds. Seed VCs are still very active, although there has been a clear pullback in investment from angel investors. Pricing is all over the place, with the hottest or hypiest companies still raising big rounds at high prices and others cutting their big seed round into a smaller chunk at a more reasonable valuation, aiming to hit more milestones and raise the rest later. Pragmatism is key right now.

What are VCs looking for when evaluating a start-up in today’s market?

More than ever, it’s a good time to stay focused on your core technology differentiation or area of unique domain expertise. Tell the story of a clear, ambitious long-term vision, and how you will build a team to address that at a huge scale over time.

However, it’s also an excellent time to start with a narrower initial focus from a product and customer perspective. Identify your highest-fit customer segment, deeply understand that customer's problem (listening to their words, not just yours), and focus on delighting that initial segment so much that they become enthusiastic advocates. That will help when you want to raise the next amount of capital to go after the next segment and broaden your addressable customer market.

Here are some of the other essential criteria that VCs think about as you go through the journey with them (all of these scales with stage):

• Basic qualification: Stage, geography, possibly sector, etc. Is it in a core focus area for us, or one we especially want to learn more about? Otherwise, it might be interesting, but not a top priority.
• In the first conversation, we’ll assess the clarity of vision, your understanding of the customer’s problem, and whether the technology is differentiated. Team fit with tech/domain/problem is an important factor, and whether you can attract talent (as well as customers and capital). Do you and your team have the vision, hustle and grit to figure out a big addressable market and how to reach it? VCs also look for momentum and a fast trajectory, whether measured by revenue growth or other milestones.
• As the conversation continues, the VC needs to figure out whether they are excited enough about this opportunity. Does the excitement build up further after more of the VC’s investment team has heard your pitch? The initial champion is your best advocate - but if that’s not a partner or principal who leads deals, you’ll also want to see a senior person involved at some point. If not, maybe you haven’t captured enough mindshare to be a must-do deal.
• In further meetings and e-mail dialogue, we’ll build out our investment thesis. We’ll get into the growth plan, how the go-to-market will develop and whether it is realistic. We will also dig deeper into tech differentiation and competition. In parallel, we’ll start to do a bunch of calls with people who know the market, deeply understand the technology, or might have encountered the business or founders.
• We’ll also start talking about how the deal might come together, test the founders’ thinking on ideal round size and think ahead to what the company needs to prove by the next funding round. And we’ll look to understand the funding history and check there are no surprises in the cap table or company structure.
• Throughout this process, we’ll work on how to best support the company on its near-term and long-term growth plan, what introductions would be most valuable and who we can bring around the founders to provide specialist support.

International expansion is another important consideration in the fundraising conversation - not just as a plan to grow, but also as it relates to the total addressable market and how big your company could become.

• If your business model has a very large home market, then internationalising might not be urgent. Some high-level thinking will be expected, but a full plan can probably wait until post-fundraising.
• If you’re in a space where the local market is capped (for example, healthcare services in the UK where the NHS is the monopoly buyer) or where there is a well-funded, well-run direct competitor in a larger market that will likely expand into yours, then fast international expansion is usually essential. This needs to be baked into the plan and round size of the Series A, with proof points needed before a Series B.
• Some companies are global from day one, or their product can be sold everywhere (like companies selling to developers and many product-led growth companies, or some life sciences start-ups). These companies can probably cope without a local presence for a while, and the addressable market size is often self-evidently global.

In any case, international expansion usually takes longer and is more expensive than founders think, so it needs to be factored into the size of the funding round and runway expectations.

What is MMC focusing on?

At MMC, we’re actively completing new Series A and Seed investments, with more planned in 2023. We focus on companies applying cutting-edge technologies in large enterprise markets, from software and data infrastructure to fintech and digital health. With over 20 years of track record, we have helped many of our portfolio company founders to navigate changing market conditions.