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VC Scrutiny Increases with Stock Market Volatility

Posted on Feb 26, 2016 in Venture Capital, Blog by David C. Lee

The past few months have been volatile for the stock market to say the least, with sharp swings becoming something of a new normal. That volatility has had created widespread anxiety, particularly for start-ups and their investors.

As this kind of roller coaster market continues, start-ups are beginning to get a recurring question from venture capitalists: How soon can you produce profits? Mounting concerns about slowing global spending are hammering U.S. stocks and investors are demanding to see a start-up’s back-up financial plans, spooked that economic conditions could worsen. They are looking for ways to be nimble amid a surge in market volatility—even if that means buying nothing at all – and start-ups are feeling the heat as investors return to a level of scrutiny that has not been seen in the past few years.

Because investors rely on large gains from an IPO to generate returns, they become very cautious about deal making when stock prices drop. This means that start-ups must return to more cautious fundraising expectations, and those without a solid financial plan and an ability to produce profits quickly will have a tougher time securing financing for the foreseeable future.

Many of the “unicorn” start-up companies that have raised financing at valuations exceeding $1B, but are not yet profitable, will have a very difficult time adjusting to this new reality. If they have to raise money in the near term, they may be forced to raise money at a much lower valuation than previous rounds.Such down-round financings can cause huge disruption for both existing investors and employees, and create a negative dynamic in the company that will be incredibly hard to overcome.

Start-ups should also be prepared to be more flexible in their negotiations, especially when it comes to the negotiation window. Many have become used to an easy sell and a quick close, but what was once a speedy process will likely take much longer now as investors are much more thoughtful and require a more rigorous due diligence process up front.

There is hope that this volatile market will even out soon, but investors could still be wary as the global market remains unstable. In the meantime, patience might be the best recommendation for start-ups seeking funding in today’s volatile market.

David C. Lee is a Partner at VLP. His practice focuses on the representation of high-growth, venture-backed emerging companies, and the investors who fund and support such companies. He has over twenty years of experience handling corporate formation issues, venture capital financings, mergers and acquisitions, public offerings, public company securities law, technology licensing transactions and employment and executive compensation matters.

The VLP Speaks blog is made available for educational purposes only, to give you general information and a general understanding of the law, not to provide specific legal advice. By using this blog site, you understand and acknowledge that no attorney-client relationship is formed between you and VLP Law Group LLP, nor should any such relationship be implied. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.