For Bijan Moallemi and other startup entrepreneurs, the rules of the game for raising venture capital have changed over the past year or so.
Moallemi is co-founder and chief executive of Mosaic — a San Diego strategic finance software startup that delivers technology tools to chief financial officers. In April 2022, when Mosaic raised a second round of venture capital, investors cared most about rapid customer s and revenue growth. As long as the top line continued to climb, follow-on venture funding likely would be available.
Fast forward to this year, when Mosaic set out to raise $26 million in a third round of funding. While the company posted a 300 percent revenue gain in 2022, potential investors dug into the details of its spending. They prodded executives over the road map to profitability, the long-term durability of the business and its valuation compared with similar companies, among other things.
“There is a lot more scrutiny,” said Moallemi. “They are asking really tough questions, which is different than a couple of years ago where there was a lot of FOMO (fear of missing out) on the investor side.”
Earlier this month, Mosaic successfully completed its third round of funding, led by new backer OMERS Ventures, with participation from existing investors, Founders Fund, General Catalyst, and Friends and Family Capital.
The funding came, however, after Mosaic took steps to become more efficient —including trimming its headcount by 15 workers over the past year. The company now employs 85 people.
“Being in the finance space — we have three CFOs as co-founders — we realized the rules of the game were changing, and we needed to course correct and change the way we were running the business,” said Moallemi.
Startups here and across the country are facing similar changes in the funding landscape as they seek to raise additional capital.
In the first quarter, venture capital flowing into young San Diego County companies came in at $588 million, down 30 percent over the same quarter last year, according to data from the Venture Monitor report from research firm PitchBook and the National Venture Capital Association.
That amount is equivalent to startup funding in the first quarter of 2019 — before the pandemic-era boom. Much of the money in the first quarter went to biotech and health care companies, a sector that has long been the key pillar of the region’s venture capital activity.
While today’s funding crunch is being felt across all stages of the startup lifecycle — from companies just starting out to those on the cusp of an initial public stock offering (IPO) — the difficulty in raising money seems to be growing for mid- to later-stage startups.
“I think where companies have been particularly impacted is Series B and beyond,” said Clare Ozawa, managing director of Versant Ventures, in a recent interview. “The IPO market went from being extremely hot to being a lot more selective. That means the finance environment for later stage companies has become tighter.”
Versant Ventures invests mostly in biotech companies, but venture capitalists focused on software, hardware and other technology startups are facing a similar trend.
“In 2023, we’re on pace to see the lowest volume of Series C venture capital deals in years,” said Eugene Lee, partner at OMERS Ventures. “Companies that can raise a Series C in this environment need to showcase massive potential, which we saw in Mosaic.”
During the pandemic funding boom, valuations often got overheated, said Rory Moore, head of startup incubator EvoNexus.
“There was a lot of money thrown at deals to get first-mover advantage,” he said. “Your balance sheet can be a weapon. You hire like crazy. It was all about growth — not earnings — just revenue growth.”
Now that’s changed.
“The triage is getting close to ending, choosing who survives and who doesn’t,” said Moore. “The companies that we see at EvoNexus that have raised an A round or a B round or a C round, investors are saying get to profitability.”
Nationwide, $37 billion in venture capital flowed to startups in the first quarter — down roughly 50 percent from the same quarter a year earlier, according to Venture Monitor. San Diego ranked 12th nationally for startup funding in the first quarter.
In the wake of the pullback, some venture firms are opting for “insider rounds” for their portfolio companies, said Mike Krenn, who runs Connect/San Diego Venture Group. That means they’re not bringing in new investors, who likely would demand a reset of valuations at lower levels.
Instead, they’re providing bridge funding to help their startups get to a point where sales and earnings validate the valuations that they achieved during the boom years — or at least come close enough that startups can raise additional capital from new investors without a large valuation haircut.
“If you have a company where you think, with a little bit more money and with a little bit more runway, they will get to the spot where they can justify that valuation, that’s good in today’s market,” said Krenn. “I think (venture funds) are all doing that internal drill as they figure out where to place their bets in their existing portfolios, and it is just taking a lot of time.”
For Mosaic, this latest funding round should be the last that the company needs, said Moallemi, though the founders might consider additional investment under the right circumstances.
Mosaic has corralled a total of $72 million since it was founded four years ago. Moallemi said he feels fortunate that the company was able to raise this latest round when it did.
“A vast amount of venture capital-backed companies are not profitable,” he said. “There are not a lot of deals getting done. I feel like you might see a big crop of companies over the next six to 12 months that are on their last bit of capital trying to go back to investors. When there are so many folks actively trying to raise money, that can make it even tougher. ”
