Financing Strategies Amid Economic Uncertainty
One of the fundamental roles of any founder or CEO is fueling the business with the resources it needs to function. These resources come in two primary forms: talented employees to do the work and capital to sustain and grow the company.
At the current precarious economic moment, the second part of this equation has become tougher, particularly for new ventures looking to get off the ground. Unlike many of their larger, more capital-rich counterparts, smaller operations are feeling the financial crunch, whether they’re seeking loans from a banking partner or investments from a venture capital or private equity firm.
Part of the issue is a set of mixed economic signals. Is the United States about to see its next big financial crash? Or is this just the beginning of the next bull cycle? The answer depends on which analyst or economist you talk to. While some economic indicators look healthy, others are flashing red: The country is currently seeing its highest level of corporate bankruptcies—ever. The rate of inflation is falling, though prices are still up significantly. And a potential meltdown in commercial real estate looms on the horizon.
Given this reality, what is a business owner who seeks capital to do?
The first question to ask concerns the mix of debt and equity financing you seek.
For entrepreneurs who want to preserve equity and their capitalization table, and who can afford interest payments to a lender, it may make sense to load up on debt. But for other ventures—those for which debt repayment would be a monthly struggle—taking on that much debt would be highly unwise. Selling equity to a venture capital (VC) or private equity (PE) firm is likely the better option for business owners in that situation, allowing them to improve cash flow without the need to immediately start paying back a loan.
While VC generally focuses on early-stage companies and PE on larger, more established businesses, this has shifted somewhat. PE has increasingly encroached into traditional VC territory, in terms of both company size and check size, with some PE firms making smaller investments in smaller companies. Historically, for a company that was a few years old and doing a couple million in revenue, PE funding wouldn’t have made sense, though today it might.
If you’re looking to secure new funding for your business, it’s wise to understand the current state of the landscape in Texas. To that end, let’s take a look at both equity and debt funding, starting with the former.
The good news for business owners is that both PE and VC firms are steadily making investments in Texas-based businesses, economic uncertainty notwithstanding. Private equity as a whole has money to throw around right now, and the investing patterns of venture capitalists haven’t changed dramatically either, especially when it comes to early-stage companies.
At LiveOak Venture Partners, an Austin-based venture capital firm, founding partner Venu Shamapant says that the investment thesis hasn’t changed. LiveOak is an entrepreneur-first investor, largely sector agnostic, that focuses on early-stage companies in Texas. That basic strategy isn’t necessarily impacted by issues in the broader economy, Shamapant says. “As long as it’s a great entrepreneur going after a big problem and they’re based here [in Texas] where we can work with them collaboratively, that’s still interesting to us.”
Shamapant notes, though, that later-stage investors may be more affected by macroeconomic conditions than LiveOak is currently. In deals with more mature companies, depressed valuations can be a hurdle, and securing financing can be more difficult.
Eric Engineer, a partner at Austin-based S3 Ventures, another prominent venture capital firm focused on Texas, echoes Shamapant, saying that S3’s investment thesis has not altered with macroeconomic changes. “We like to say that ‘Texas is our thesis,’ and that has not changed,” Engineer says. “We are patient, long-term investors and still believe Texas has the potential to be the second-largest tech innovation ecosystem in the country by 2030.”
Engineer points to Texas’ capacity to attract record numbers of entrepreneurial and technical talent as part of why he has so much faith in the state. “That is a decades-long trend, and we don’t see it slowing down anytime soon,” he says.
That said, startup valuations have shrunk over the past couple of years as interest rates grew and the investing climate worsened. Artificial intelligence (AI) companies appear to be immune, with ongoing interest fueled by the success of OpenAI, maker of DALL-E and ChatGPT. Mark Sherman, managing director at Telstra Ventures, recently told Crunchbase that AI startups are getting valuations that are two to six times more than non-AI tech companies.
For Engineer, the lowering of valuations isn’t a negative development per se. “On average, valuations are roughly half of what they were at the peak in 2021, but that is a healthy phenomenon and a return to more normal, sustainable levels,” he says. “We’ve simply returned to 2018–19 levels. That being said, we are still seeing rich valuations for the fastest-growing companies, as well as those with riding the latest wave of excitement around AI.”
Shamapant adds that valuation fluctuations in Texas have not been as extreme as in other parts of the country. “Before these macroeconomic changes, Texas-based company valuations had expanded, but not to the levels of Bay Area- or New York-based companies. Relatively speaking, Texas-based valuations were more reasonable to begin with and therefore did not have as much compression to go under. While there’s now more focus on making sure valuations are appropriate, we never got too carried away in the first place.”
Shamapant hasn’t seen much of a slowdown in deal volume, but he does expect round size to compress somewhat. “We have a couple of companies right now that have financing term sheets in place for $20–$25 million rounds,” he says. “In the good old days, these companies could probably have gone out and raised 50 million bucks. But increasingly, growth-stage rounds are shrinking a bit as valuations normalize. At the end of the day, entrepreneurs think about how much dilution they are taking in each round; right now, many are taking a little less money and trying to make it last longer and go further.”
For his part, Engineer has seen a slowdown in startups going to the capital markets over the past six to 12 months. “Most VC-backed startups made cuts and looked to inside investors to extend their runways with the hope of growing into their valuations over the next year,” Engineer says. “This phenomenon was broad-based, but it was most acute at the later stages, where valuations dropped the most in dollar terms. We expect Series A/B deal activity to pick up significantly by Q4 of this year, as those extension funds will start to run out. However, we’re already starting to see activity pick up at the seed stage.”
Business owners seeking funding can’t be blamed for looking to the banking sector with some trepidation in 2023.
For one, the Federal Reserve has recently increased interest rates faster than ever in history, impacting loans across the county. Earlier this year, we all watched as several high-profile banks failed, including Silicon Valley Bank. In the early months of 2023, more banks took emergency lending from the Federal Reserve than in the 2008–09 financial crisis. Along with the resultant depositor skittishness, banks both large and small have grown more cautious about lending as they aim to keep their balance sheets secure. All this adds up to a lending landscape that’s tighter and less predictable than it’s been in a while. Loan applicants who would’ve been shoo-ins previously may now struggle to secure a business loan.
Small-business owners are keeping a close eye on the situation; the number who anticipate better credit conditions in the next three months hit a low point in January, according to the National Federation of Independent Business.
At the same time, banks in Texas as a whole don’t seem to be making too much of a lending pullback, particularly in high-growth areas of the state such as North Texas.
Susser Bank, founded in 1959 and based in Dallas, is one of the fastest-growing banks in the region and declares it remains fully committed to lending in the technology space. More specifically, the bank’s focus is on SaaS technology companies with more than $3 million in ARR, established product/market fit, and excellent management teams.
Annalese Smolik, director of technology banking at Susser Bank, says the institution is seeing its clients prepare for uncertainty. “We continue to see portfolio companies have laser focus on transitioning away from cash burn for growth’s sake at all costs to strict expense management, line of sight to cash flow neutrality or positivity, and an elevated client retention effort.”
The bank is also helping leaders bolster themselves for potential market vicissitudes. “We are encouraging clients to prepare downside budgets, thoughtfully identifying first- and second-round expense cuts that can be executed swiftly and efficiently, if necessary,” Smolik adds, “given that the higher rate market and cash coffer replenishment from the VC/PE market is not as guaranteed or timely as it was, for example in 2021.”
Mandy Austin, Dallas market president at Bank of Texas, says there is still demand for loans in her region, although the bank is looking out for some potential slackening later this year or next. Austin recently told the Dallas Business Journal that demand is “up significantly” year over year, attributing this to companies depleting excess liquidity following stimulus payments during the COVID-19 pandemic. Although the bank, like so many others, is exercising caution, Austin says the Bank of Texas is “strategically well-positioned,” particularly in North Texas, and adds it is growing significantly.
Businesses and private lenders in Texas also continue to take full advantage of the Small Business Administration’s backing; Texas ranks second in the nation for SBA funds, with Lone Star State businesses taking in nearly $1.8 billion so far in 2023. In 2022, 10.9 percent of the SBA’s total funds went to Texas, a total of more than $2.8 billion on SBA 7(a) loans.
The Best of Times
Ultimately, if you’re an entrepreneur or business owner in Texas, you are likely better off in your search for funding than many others. Securing a loan may be harder, but it’s still possible. And investors here are certainly still looking for deals.
In fact, Shamapant emphasizes that in the venture business, times of macroeconomic hardship are some of the best times to start a company. “2001–2002, right after the tech bubble burst, was a great time to invest,” he says; “2008–2010 was another great time to invest.”
Shamapant points to a couple of different advantages entrepreneurs have in times of macroeconomic trouble. “Number one, frivolous companies don’t get financed [in these times], so your competition tends to be less. Number two, if you’ve got a really good solution when times are hard, your customers are more likely to try something new and innovative. If they’ve got to cut costs or find more market share and you can help them do that, they’re more likely to give it a shot.
“And finally,” Shamapant says, “by the time you bring your solution to market, hopefully things have turned around in the economy and you can go in with some wind behind you.”
Whatever the case, external conditions need not be a barrier to entrepreneurship, he adds. “If you’ve got an idea, take it seriously. Don’t let the macro markets dissuade you.”