What the heck is going on in the economy, and how will the market gyrations impact startups and venture capital? The backdrop for these questions is dynamic and complex right now.

• Venture capital investors are hitting the brakes, with funding in Q2 expected to decrease 19% quarter-over-quarter.
• Startup valuations are declining in many instances. 
• Analysts are predicting the return of dreaded “down rounds” — where companies land new funding at lower valuations.
• Well-known VC firm Andreessen Horowitz recently offered this advice to startups: “Reevaluate your valuation, understand your burn multiples, and build scenario plans.”

To help make sense of this turbulent environment, we invited Tim Porter to join us on the GeekWire Podcast. He’s a Madrona Venture Group managing director who has invested in early-stage technology startups at the Seattle-based venture capital firm for the past 15 years, focusing on cloud, AI and enterprise software companies.

Listen below, and continue reading for our notes from the discussion.

It seems a little grim out there. What are you seeing?

• These last few years have been an absolute roller-coaster, for the world, the tech market, and in the startup market, as well.
• In some ways, what’s happening now is a return to historical normalcy rather than a “sky is falling” scenario. There’s been a compression of multiples from unsustainably high levels last year. Companies are now focused a little bit more on efficiency, not just growth at all cost.
• At the same time, the world has gone through so much trauma (pandemic, wars, supply chain issues, energy shocks, inflation), and those have a real impact on businesses and individual consumers.
• It is going to be harder to fundraise in the near term. Investors have largely pressed the pause button right now. Startups need to think about extending their runway, rebalancing the trade-off between efficiency and growth. Growing a little bit less, but being a lot more efficient.
• Companies aren’t hiring as aggressively, but there aren’t widespread hiring freezes or layoffs.
• In many cases, demand from end customers is still strong. Companies have been hitting their Q1 targets, and Q2 is looking strong.
• All that said, there’s an overall sense of caution, and a recognition that there’s a need to preserve capital.

It seems like a bit of a strange downturn. It’s not so much a business or customer reset; it’s simply a market and valuation reset. Is that an accurate assumption?

• “I don’t want to say there’s zero impact in some of these end markets, but that’s largely been the case.”
• The forward revenue multiple for the top 25 fastest-growing public SaaS companies was a median of 52 at the peak on Nov. 15. Now it’s a median of eight. And so you have seen a valuation reset.
• Public companies are beating earnings expectations but tempering their forecasts due to issues including the impact of foreign exchange rates. (See Salesforce and Microsoft.)
• For hardware companies, there is also a direct impact from supply chain challenges. (See Valve’s Steam Deck dock delay.) Consumer spending has become more muted as stimulus has worked its way through the economy.
• “So I don’t want to say that there’s absolutely nothing to be concerned about around inflation and the overall economy. But most of the core trends we’re investing against — digital transformation, the move to the cloud, machine learning, the impacts of software — those all seem to be very durable.”
• Looking ahead, people seem to be in a wait-and-see mode, not slamming on the brakes, but also not putting the gas pedal to the floor.

We’ve had COVID and a war and all these supply chain issues, inflation. Entrepreneurs must be feeling like they can’t catch a break. It’s exhausting and taking a psychological toll. How are you coaching entrepreneurs to get through this?

• It has been wild. All the uncertainty and challenges of COVID in 2020, then the best fundraising market in history in 2021, the biggest run on tech valuations that we’d seen in 20 years. Now things are coming home to roost with inflation and broader global issues.
• Yet founders are resilient and optimistic. Some of the best companies were created in past downturns. For Madrona, examples from the 2007-2009 era include Smartsheet, Apptio, and Extrahop.
• “We want to partner with founders who want to build something meaningful and sustainable for the long term. Cycles are going to go up, and they’re going to go down. … And so you just have to respond, put your head down and keep building.”
• “We try to always have a view of, every dollar demands a return. And if you see an opportunity, yes, be aggressive and invest against it. But don’t just pour money on something because money is available.”
• That type of efficient growth mindset is what people are focused on right now.

Let’s say you’re an entrepreneur at the end of your Series A financing round, and going out for your Series B. What’s your advice for that entrepreneur?

Madrona is still figuring this out right now with several factors in mind.

• Very late-stage private markets are essentially closed right now.
• Up until three weeks ago, the very early stage market (pre-seed and seed investing) was cranking along. We saw a lot of early stage deals continuing to get done at robust prices. In the last three weeks, that market has started to slow.
• In the Web3 world, the meltdown of Terra and Luna has contributed to a slowdown.
• At the same time, the bar for startups to show progress in their metrics has been raised, with a greater focus on capital efficiency. Valuations are less than what entrepreneurs previously anticipated as a result.

So the advice is, if you don’t need to raise, don’t. Instead, extend your runway to achieve more with existing capital. If you need to raise now, consider a smaller round, and readjust your thoughts about valuation. Play for the long run, make your pie bigger down the road, don’t just focus on dilution now.

We’re seeing hiring cutbacks from small companies to big ones. What are you seeing as it relates to hiring? Is this an opportunity for earlier stage companies to grab talent?

• It does seem like an opportunity. Just as in the funding markets, there’s a cascading impact in the talent market that starts with later-stage companies and trickles down to earlier-stage companies. It takes a while.
• The competition for talent has just been intense in Seattle in recent years, certainly on the technical and engineering side, but also on sales and marketing.
• “It still is pretty competitive from what I’m seeing. But I think it’s going to ease, and get a little bit more normalized here in the back half of the year and into next year.”

It’s another example of this being a strange downturn — all these macroeconomic issues and yet hiring is still keeping up and customers are still coming. How much of this is groupthink versus reality?

• One popular observation is that the technology market moves swiftly from greed to fear. When it moves to fear, all these things build on each other.
• One truism through many cycles is that when a downturn is coming, you never want to react too late.
• However, things haven’t just completely stopped. There is opportunity to build. It really depends on your business, runway, and end market.
• The move toward efficiency is real and needed. You don’t want to go into pure survival mode, but you also don’t want to ignore the warning signs and burn through your money.
• Tim hasn’t yet seen any down rounds (where the valuation was lower in a new round than it was previously). However, there was a deal where the price was adjust down in real time, through a collaborative discussion between the investors and founders.

Does a downturn like this change your investment focus?

• “It largely does not. We are trying to invest in trends that we think are decade-plus-long trends, and invest really early for companies that can build over the long term. And so that hasn’t changed at all.”
• Madrona’s pace of investing has also stayed relatively steady.
• One thing that slows things down is price discovery, determining how to value companies. So there will probably be a slower pace of follow-on rounds vs. the prior year. New investments might slow, but to a lesser degree.

Is there something specific about this downturn that concerns you the most?

“I think it’s whether inflation and a broader slowing in the world economy will turn this into a much longer downturn or recession. How long will this last? The longer it lasts, the more I think you will see markets having to pull back. … Will it turn into a full-on recession? I’m not sure. And we’re hoping not. But that’s the question.”

How concerned are you on a scale of 1-10, with 1 being no concern, and 10 being massive devastation?

Seven. “I think it’s going to be a harder fundraising market for some time here. And I think that there are some broader issues around inflation and the economy. I don’t think it’s a 10. I don’t think it’s as bad as in the Great Recession in 2008. But I also think you have to show appropriate caution and be really focused on efficiency, and really understanding the forward indicators of your business to see how things are going to continue to respond.”

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