Finance

Startups look towards alternative sources of funding

As VCs keep their powder dry, CFOs of startups look for more creative ways to raise cash.
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· 5 min read

In an increasingly tight macroeconomic environment, venture capitalists are finding out that they’re just like the rest of us, holding on to the purse strings a little tighter and keeping—rather than spending or investing—any loose change accumulated over the past two years.

Dry powder—the estimated amount of cash VCs have at their disposal—has been used to gauge how well the startup sphere is doing, and its ability for growth. And with the funding that flowed freely in 2021 slowing to barely a trickle, startup companies are left seeking other ways to raise money without tying their companies, and their equity, to VCs.

The latest PitchBook Data shows that in the first three quarters of 2022, “US-based VC funds have raised $150.9 billion, surpassing last year’s previous record and taking the 21-month fundraising total above $298.1 billion.” While that number might appear high, it doesn’t necessarily mean that VCs are able to write big checks.

Micah Rosenbloom, general partner at seed-stage VC fund Founder Collective, wrote in Harvard Business Review last month that VCs will likely keep their powder dry, or reserve funding, for their most promising existing portfolio companies. Cash flow could also slow down if wary limited partners (LPs) of pension funds, endowments, and similar funds start to reconsider their commitments to VCs.

Still, the talk of dry powder became quite the hot topic last month, setting off a debate on Twitter between optimists and pessimists.

Among those leaning toward pessimism is startup incubator Y Combinator, known for hosting high-profile startups like Stripe and Instacart. In a May letter to its portfolio companies, YC warned founders to brace themselves: “If your plan is to raise money in the next 6–12 months, you might be raising at the peak of the downturn,” the letter reads. Earlier in the letter, YC wrote, “The safe move is to plan for the worst.”

But startup CFOs might be scratching their heads on just how that is possible. In a startup world that traditionally has worked hand in glove with venture capitalists, how can one circumvent the Silicon Valley crowd (or is it Miami? Or Austin?) and still have a viable cash flow?

Fundrise, a startup that allows real-estate crowdfunding, decided to try a different path.  “Our CEO wanted to maintain the ability to control his own destiny,” Alison Staloch, CFO at Fundrise, told CFO Brew. Initially, the firm explored crowdfunding to develop its own platform, but that experiment was short-lived as it wasn’t scalable or what people wanted, Staloch said.

So, Fundrise used Regulation A+ (tier two), an esoteric securities law that allowed it to maintain control but also let investors purchase shares in the company. The structure allows private companies to raise up to $75 million in a 12-month period by allowing non-accredited investors to buy securities.

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Fundrise next turned to the Investment Company Act of 1940 (aka the 40 Act), which allows firms to tap into the unaccredited, or retail investor market. Shifting from Regulation A+ to the 40 Act isn’t an overnight process, however; Staloch said that it requires a little more discipline and board governance.

Staloch previously worked as the chief accountant for the SEC’s Division of Investment Management and brought that expertise to her role as Fundrise’s CFO.

Investing via the 40 Act isn’t all that different from VC investments, where investors aren’t necessarily expecting a quick turnaround, according to iCapital, an alternative investment platform. According to the firm, “regardless of the liquidity terms, these [40 Act funds] are fundamentally longer-term holdings and should be viewed as such in a broader portfolio.”

“We think there are some really good venture funds out there…They provide a lot of value, like really smart people.” Staloch said. She added that there are thousands of VCs, many of whom have never been founders themselves, and don’t know what it’s like to start a company. They’ll typically come in with demands to cut costs or make money with an eye toward increasing their personal stake in the company, so they can turn around and launch another fund, and charge fees. “They’re just really in it for the short term,” Staloch said, which is not what most startups need.

While Fundrise went on a different path, that’s not to say that all startup CFOs are willing to ditch VCs or have seen a massive sea change. Josh Weiss, head of finance at Render, a cloud-application platform, told CFO Brew that while conversations haven’t been that different than discussions in the past, investors are somewhat more interested in a path to profitability than they were in the past.

“But that’s something that happens…during rough economic times,” Weiss said. “VCs sort of shift their emphasis from just straight up revenue growth to ‘What is the probability that this company is actually going to become profitable in a shorter timeframe than we would ordinarily bring it out?’ That’s the VC’s perspective.”

For her part, Staloch said there isn’t a perfect path to follow in startup funding that doesn’t involve VCs but their process didn’t drastically change the startup evolution, saying “the next step will probably be a public offering, at some point. [First,] we’ll get through a recession.”—KT

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