The Crucial Choice: VC Track or PE Track?
How an Increasingly Challenging Fundraising Climate Means Hard Choices
The current fundraising environment for B2B SaaS companies is more challenging than it has been in years. While venture capital firms still have ample dry powder, they have largely retreated to shoring up existing investments (or investing in AI!) and are being far more selective with their investments. For founders of post-seed B2B SaaS companies that have raised some funding but are struggling to achieve the growth rates required to raise a Series A on the venture track, this poses an existential question: continue pushing for venture scale at all costs or explore alternative paths to a meaningful outcome for the founders and team?
This article is aimed at founders in this position, caught between the venture capital (VC) and private equity (PE) tracks, and unsure which direction will lead to the best outcome for their companies and teams. Here we define the key characteristics of the VC and PE tracks, discuss the factors influencing the choice between them, outline the potential benefits and risks of each, and advise on appropriate timing for making a switch. The goal is to provide founders the information and perspective necessary to make an informed decision about their companies’ futures.
Definition and Characteristics of VC and PE Tracks
The VC Track: IPO or bust funded by moar money
The venture capital track is characterized by expectations of rapid growth - typically 1-200% year-over-year or more. Companies without that kind of growth who are continuing to pursue venture capital are making a bet that with enough fuel (funding), they'll be able to find a new growth channel, product tweak or partnership that sparks hyper growth so they will eventually be able sell to a strategic or IPO.
The PE Track: get to breakeven
In contrast, the private equity track is where you cut cost to get to profitability (so you don’t need to raise any more) and perhaps accept slower, linear growth, often in the 20-50% YoY range. This then puts you on a path to (at a time of your choosing) sell to Private Equity, operate the business for profit indefinitely or even get back on the VC track when the fundraising climate improves.
The Crucial Choice: VC or PE Track?
Several factors influence whether a company is better suited to continue pursuing venture capital or whether it should consider switching to the private equity track:
Growth Trajectory: Step back and honestly evaluate your company's growth over the past year relative to plans and projections. If growth has stalled or at least is below 100% year over year, the VC track may no longer be viable.
Runway: If you don’t have the growth required, does your company have sufficient runway at current burn rates to return to VC path type growth AND have sufficient time to actually raise the next round once that’s been proven out? Be realistic with yourself and your team. If you don’t have this, it’s better to cut now than wait until you’re forced into a fire sale or to be shut down.
Risk Appetite: Consider your personal risk appetite as founders, and your obligation to any existing investors or employees. Staying on the venture track when the probability of failure is high may not align well with these responsibilities. The PE track can reduce that risk.
Control: Do you want to retain control of your company and its direction or cede some control to new VC investors to fuel rapid growth? With a company at breakeven, founders can maintain control.
While staying on the venture capital track holds out the promise of a very large outcome if everything goes right, the odds today are stacked against most companies that aren’t already at the growth rate they need to be at to raise that Series A or B. The private equity path provides an opportunity to build a sustainable, profitable company, even at a smaller scale. For many, this may be the better overall outcome.
It’s also important to consider how various preference stacks and veto rights that come with further VC fundraising will do to the chances that the founders get any kind of meaningful outcome at all. If your Series A includes a 3x liquidation preferences with a cram down, that may mean the likelihood of the founder and the team getting anything at all with an eventual exit is vanishingly small.
Tough Choices and Their Implications
Opting to switch from the VC track to the PE track is not easy and often requires making difficult decisions to align costs and extend runway. This may include reducing headcount, cutting marketing and sales expenditures, eliminating expensive offices, and streamlining operations. However, as hard as these choices are, not making them risks ending up in a worse position with few options left and the likelihood of failure high.
Some facts to consider:
The median tech startup only has about 15 months of runway (about $500K) at any given time. Wait too long to take action and options narrow quickly.
It is easier to find an acquirer or raise funding from a position of strength when you still have 12-18 months of resources left rather than 3-6 months. Desperation leads to poor outcomes.
Downsizing, while painful, is often necessary for sustainability at a smaller scale. It provides the opportunity to build a profitable company suited for the PE track. Avoiding this may just prolong the inevitable.
While difficult, these types of actions help ensure you end up with an operating company able to choose its own path, rather than out of funds and out of options. This is always the preferable position. With sustainability achieved, new opportunities tend to emerge over time.
The Importance of Timing and Preparation
For most companies on the venture track but struggling to stay there, time is of the essence. The runway gets shorter each day that passes without a change in strategy or infusion of new capital. However, it is also important not to make snap decisions out of desperation. Rash choices often lead to poor outcomes.
Some recommendations:
Take 2-3 weeks to evaluate options objectively before finalizing the decision to switch tracks. But don't wait too long or options narrow quickly.
Use the evaluation period to analyze historical run rates, project multiples growth scenarios, cut any unnecessary expenditures, and determine a path to sustainability at a lower cost base. You want to negotiate from a position of strength.
Consult with mentors and advisors who have experience guiding companies through situations like this (feel free to get in touch if you want a third party to help you consider your options: einar@discretioncapital.com) .
If opting to switch to the PE track, determine the minimum funding needed (if any) to get to profitability and your key metrics for potential investors/acquirers so you know what deal terms are acceptable.
While the current climate is challenging for B2B SaaS companies seeking to raise capital, with prudent decision making and preparation a sustainable path forward can be found. The choice between VC track and PE track is difficult but can be made objectively by evaluating your specific situation against the various factors discussed here. The outcome may not be what was originally envisioned but can position the company to live to fight another day.
Now is the Time to Act
Please take the time today to evaluate your company's current position objectively and weigh the benefits and drawbacks of staying on the VC track or switching to the PE track. A sustainable future for your company and team is at stake, and your decision may determine if you get paid at all for your hard work so far.
If additional perspective or advice would be helpful in this process, feel free to contact us for a confidential, no obligation consultations. We guarantee we’ve seen hairier situations than yours..