Fishing in Venture

Fishing in Venture crew — I am writing this as Hurricane Helene’s is whipping through our area (and patching a few holes in our roof!). I hope everyone is staying dry. It is exciting to get back in the saddle of writing as the market has shifted a bit since my last post. As always, I’d love to hear from you! Please feel free to reply or contact me and I’d love to chat.

Late-Stage Valuation Compression: What it Means for Founders and Investors

As we navigate the current venture capital landscape, it’s impossible to ignore the growing conversation around late-stage valuation compression. For all the people who don’t know what that means — here is a quick hit. Late-stage companies are typically Series B and beyond in their maturity. They usually have strong revenue growth and have raised 10s of millions of dollars. Their valuations have taken the biggest hit over the past 18 months mainly because of how close they are to the public markets. Early-stage companies were a bit more insulated from macroeconomic pressures. After years of skyrocketing valuations, we’re seeing a sharp reversal in the market. While this has mostly affected late-stage startups, it’s been a setting for the VC ecosystem in the past 18 months

Valuation compression happens when a company’s valuation in subsequent funding rounds is lower than expected, often due to changes in market conditions rather than internal performance. In 2021, we witnessed an unprecedented surge in late-stage valuations, but as the economy cooled down and capital became more cautious, those same companies are now facing downward pressure. Thomas Laffont talked about this extensively at the All In Summit last week. You can watch his video here.

So, what’s driving this? Well, investor sentiment plays a huge role. With the Federal Reserve keeping interest rates high (although the recent cut should bring some change), the cost of capital has increased, and investors are more risk-averse. Rather than chasing unicorns, many are pulling back to fundamentals like profitability and sustainable growth. For many late-stage companies, this means their once lofty valuations are now being re-assessed to lower and lower valuations. Thus, hurting both existing investors and companies

Additionally, there’s a liquidity crisis for many venture funds. With fewer exits via IPOs or acquisitions, funds are holding onto companies longer than expected. This is compressing valuations further, as investors realize they’re not going to get the high-flying exits they once anticipated.

Founders:

For founders, valuation compression can feel like a gut punch. If your Series C or D is priced lower than anticipated, it could mean significant dilution, especially for early employees and founders who’ve been holding on. This also impacts the company’s ability to attract top talent, as stock options are no longer the attractive compensation they once were.

However, not all hope is lost. Founders are finding ways to pivot by cutting burn rates, focusing on profitability earlier than planned, or seeking out non-dilutive funding options like revenue-based financing (which we’ve discussed before).

Investors:

For VCs, the name of the game right now is discipline. Investors who jumped in at high valuations may face longer time horizons for their exits or reduced returns. However, those entering the game now may find more reasonable entry points, with better-priced deals available due to the compression. It’s all about timing, patience, and recalibrating expectations for the long term.

While the downturn in late-stage valuations is forcing tough decisions for both founders and investors, it also presents an opportunity to refocus on building sustainable, long-term value. Just as fishing requires patience and adjusting to changing conditions, so does venture capital. Sometimes, when the waters are tough, you need to reset your strategy, tighten the lines, and wait for the right opportunity to hook the next big catch.

Sources: Carta’s 2024 Q1 Report on Private Markets

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Fish of the Week

Coral Vita – Breathing Life Back into the Ocean

This week’s Fish of the Week takes us into the depths of the ocean—an apt setting for our fishing theme! Coral Vita, a startup born out of the need to address one of the most pressing environmental crises of our time, is working to restore dying coral reefs through land-based coral farms. These farms grow resilient corals at an accelerated rate and then transplant them back into the ocean to revive marine ecosystems.

Founded by Sam Teicher and Gator Halpern, Coral Vita was inspired by a deep love for the ocean and the devastating impact climate change is having on marine life. Coral reefs, often referred to as the “rainforests of the sea,” support 25% of all marine species and provide crucial economic benefits through fisheries and tourism. However, these vibrant ecosystems are being decimated by rising ocean temperatures, pollution, and overfishing.

Coral Vita has developed a breakthrough process known as “assisted evolution”, where they breed corals to be more resilient to climate change. By growing corals in controlled environments, they can speed up growth rates by up to 50 times, making large-scale restoration efforts possible.

What makes Coral Vita a compelling story for the venture world is not just its environmental mission but its business model. The startup works with coastal property owners, governments, and conservation organizations to fund restoration projects. They’re proving that environmental impact and profitability can coexist—something more investors are starting to pay attention to.

Just as fly fishing requires finding the perfect spot and casting at the right time, Coral Vita is working in the critical intersection of timing, innovation, and environmental necessity. They’ve found the sweet spot where mission-driven work and business strategy meet, and they’re reeling in attention from both environmentalists and investors alike. It’s proof that sometimes, the best solutions come from looking beneath the surface, adapting, and casting your net wide.

For more detailed information, visit their Crunchbase profile.

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Ebbs & Flows

Pro Rata Rights

In venture capital, pro rata rights can be a game-changer for early investors. If you’ve heard the term but aren’t exactly sure how it works, you’re not alone. Pro rata rights are a provision in the term sheet of a fundraising round that gives investors the option to maintain their ownership percentage by participating in future funding rounds. So, if an investor owns 10% of your company after a Seed round, pro rata rights ensure they can invest in the next round to keep that 10% stake intact (investing at the new share price).

For founders, pro rata rights are important when negotiating early-stage deals because they directly impact how much future dilution you’ll face. If all your early investors exercise their pro rata rights, you may need to issue less new equity to bring in fresh capital. However, it’s also a balancing act—giving too many investors these rights can complicate your cap table and make it harder to raise future rounds if new investors want significant stakes.

Pro Rata Rights Matter for VCs:

From the investor’s side, pro rata is crucial for investments that hit it big. Early investors get to double down on their best-performing startups, which increases their chances of generating higher returns. It’s like getting a chance to reel in a bigger fish after already catching one—an opportunity no VC wants to miss. Now, you don’t always have to take your pro rata investment. If the startup isn’t doing well, then you can simply opt out of the round and your initial investment will be diluted. 

I was actually reading that there are some funds now that have a specific thesis to invest in other peoples pro rata options. If the standing investor does not elect to pursue their pro rata investment, these funds will buy that portion of their pro rata and take a carry fee on any returns. Feel free to dive into the TechCrunch article here.

Negotiation Considerations:

When negotiating pro rata rights, founders need to consider:

• Who gets them: Usually reserved for institutional investors or significant early backers.
• Dilution: How much room you leave for new investors as more pro rata rights are exercised.
• Investor Relations: Managing relationships with both existing and new investors becomes critical.

Sources: Investopedia: Pro Rata Rights Explained

Thank you for your support!

Dawson J. Racek