Astella's Edson Rigonatti's Advice to Entrepreneurs: Preserve Cash

^{Written by Ralphe Manzoni and orignally published at Neofeed}

In an interview with NeoFeed, Edson Rigonatti, a partner at Astella, says that the frenzy and opulence of high valuations has come to an end for mature startups and that the recommendation is to use the money sparingly.

Just before this interview began, Edson Rigonatti, founder and partner of Astella Investimentos , sent two graphics that would support the conversation that you can read below. 

In the first, a survey based on Pitchbook data that starts in 2006 and ends in the first three months of 2022 shows a drop of more than 20% in the valuations of late-stage startups when compared to last year. 

The second graph shows the same historical series. The difference is that it takes into account valuations in early stage startups. And surprise: a growth of almost 50% at this stage. Despite these data that show inverted signals in the behavior of investors when evaluating startups, Rigonatti makes a naked analysis of the current scenario: after a phase of exuberance, which was the year 2021, the venture capital market is returning to historical median.

“That means less frenzy and opulence in valuations. It also means a more cadenced market with less FOMO (acronym for “fear of missing out”)”, says the partner at Astella Investimentos, who has already invested in 47 startups, including Omie , Livance and RD Station (sold to Totvs ) . “It will be less woohoo.” 

In this interview, Rigonatti says that there were exaggerations in the rounds of some startups last year, which in some cases reached three contributions in less than 12 months and says that investors are recommending companies in their portfolios to be thrifty in the use of money. 

“The general orientation in the market is to preserve cash as much as possible and ensure the operational robustness typical of the expected next round. The focus is now operational and less just on fundraising”, says Rigonatti. 

This does not mean, in his view, not burning cash. “But burn more properly. And not simply growing for the sake of growing or hiring thinking it will grow”, says the Astella partner. This new recommendation comes after a record year of investments in startups in Brazil. In 2021, investments reached R$ 9.4 billion, three times more than the previous year. And before an oasis, companies started to lay off, as happened with QuintoAndar, Lotft and Faciliy . 

The following are the main excerpts from the interview:

 Last year, the venture capital market was a record in Brazil, reaching R$ 9.4 billion. What is the expectation for this year: will liquidity be lower? 

The expectation is for an adjustment in the entire production chain. From the exit, we are talking about IPOs and strategic transactions, up to the intermediate rounds. Where we see a greater adjustment is precisely in the late stage . From a cycle point of view, I would say it is very expected. We work a lot with this concept of reversion to the median: nothing takes much off the historical median for long without some deep reason. We expect this path to return to the median in a very healthy way. 

What does it mean: less investment? 

No. That means less frenzy and opulence in valuations . It also means a more cadenced market with less FOMO ( fear of missing out ). The industry is capitalized. The venture capital production chain has dry powder in its portfolio. 'Flight-to-safety' in the venture capital world represents a search for better quality assets, with better unit economics (the income you get from a single unit and how much it costs to obtain that unit) and with cause and effect of more substantial growth. It will be less woohoo and more structured. 

Some startups made up to three fundraising rounds in the last year. Were there exaggerations? There was. Speaking of the investor position, it was very difficult to hold. There were very high valuations that were not necessarily supported by fundamentals. This is gonna change? Yes, the production chain is starting to become more demanding. Some concrete examples. The historical median for a company to raise a Series B from $20 million to $30 million was approximately $1 million in revenue per month. There were people with US$ 200,000, US$ 250,000 raising series B. There was a very large detachment of the amount of money and, consequently, a valuation for an operational level lower than the historical one.

“The historical median for a company to raise a Series B from $20 million to $30 million was approximately $1 million in revenue per month. There were people with $200,000, $250,000 raising Series B”

What explains this behavior: a lot of money in the market with a lot of competition for the businesses? 

It was an entire production chain of expectation. The market was very robust, it was paying very well. Consequently, IPOs were highly valued. A very expansionist global monetary policy, with very low interest rates worldwide, plenty of capital and liquidity. The entire production chain connects. It's like you have a perpetual river running down the water. And now that river has dried up. You see the entire bed drying up and getting what it's really good for. It's a normal healthiness of money cycles and venture capital cycles. 

Another topic is the issue of valuations . In the public market, some tech companies have lost up to 50% of their value since September last year. Has this already reached the private market? I don't believe there will be a 50% reduction in value in the private market. What changes is the speed. As you said, there was a startup that raised three rounds in one year. There was no operational reason for that to happen, other than liquidity. For 2022, what we are recommending for portfolio companies is to be prepared to have to deliver historical metrics to get back to what is expected. The contributions of series C and D overall were greatly reduced. Only high quality assets will take the step forward this year. In the venture capital market, the investor mitigates risk by making investments in a kind of ladder, the so-called series. When a startup raises three funding in a year, it often doesn't even have product market fit . So the risk is higher, isn't it? Yes, much bigger. Therefore, all investors are recommending that companies in their portfolios be sparing in the use of money, to ensure that cash takes you not only to the next year, but to the next two, three years. Until you have the operational robustness to justify the next round.

“It's like you have a perpetual river running down water. And now that river has dried up. You see the whole bed drying up and getting what really works”

This is the current mindset of investors: stop burning cash and start generating cash? 

I wouldn't say stop burning cash, because in the private world it's very difficult to grow without burning cash. But burn more properly. And not just grow for the sake of growing or hiring thinking it will grow. 

What do you call burning cash more properly? 

There were many people who did not have product market fit ( concept to validate the product or service by the market ) . There were a lot of people who didn't have a gross margin, because they sold at a discount or promotion. This is the first property: having a business with a unit economic with margin. The second is knowing how much effort it takes to make new sales. There are startups that have a very clear cause and effect. She knows that for every X number of people she hires, she sells more. There are other companies that do not have this very clear relationship. These are the two main foundations of sustainable growth: gross margin and cause and effect of sales. 

Funds that invest in early-stage startups know that failure is part of the game. That said, can many startups fall by the wayside through 2022 and 2023 at a higher-than-average rate? 

I don't expect such a large volume of mortality increase. What I expect is a significant increase in down rounds (reduced evaluation in a next round). This will happen because the size of the magnitude of sales is not consistent with that stage that the company believes it is. Although the name of the series is not very significant in terms of the company's operational size, there is a historic median size for companies that are in the A, B or C series. This operational expectation has now returned to a historic level. It will be more difficult to capture and you will have to have more operational robustness to justify the next step.

“I don't expect such a large volume of mortality increase. What I expect is a significant increase in down rounds (reduced rating in a next round)”

‍What is the effect on a startup's image when the down round happens? 

Is very difficult. There is no lack of cases in which this adjustment happened and the company still became a unicorn. There are many companies that have gone through this type of adjustment. But he always makes a dent in that typical surfer badass perspective. Sometimes we think of ourselves as this badass surfer who is after a perfect wave that doesn't exist. But it's worrying. Is it to be expected, then, that many founders will hold on to the next capture? They're going to hold on to be able to measure just that: reaching a higher operational goal versus the dilution that an adjusted round would cause. Warren Buffett has a saying that you only find out who is swimming naked when the tide is low. There are a lot of startups firing in the US and Brazil. Is this a sign of this movement of startups to readjust to start having positive unit economics ? Undoubtedly. It's a precaution. Again, the general orientation in the market is to preserve cash as much as possible and ensure the operational robustness typical of the expected next round. The focus is now operational and less just on fund raising . Has Astella changed its playbook when investing in 2022? Not much because we have this more value investing perspective . What we change is the speed of the follow ons . What does that mean? We are saving more money for follow-ons than we are making first investments.

“We are saving more money for follow-ons than we are making first investments”

Why? 

To ensure that we have the capacity to help those companies that will reach the next stage. 

Is there a difference in behavior between those who invest in early vs. late stage?

Pitchbook data already shows a big pullback in the late stage . This does not happen in early stage. 

Why? 

Early stage is historically more shielded from these fluctuations, it gives more return, even on fluctuations. And as we are three or four years ahead or behind, depending on how you look at the late stage, we are already looking at the companies that will be created this year and that will be in the next cycle in four years. Typically, early stage ups its bets in this macro retracement circumstance. 

Why do you up the ante when there is a macro pullback? 

Because there will be more problems in society. The early stage sees these cyclical macro movements as great opportunities.

“Typically, the early stage ups the ante in this macro pullback circumstance”

What advice would you give entrepreneurs at this time when it's more difficult to fundraise? 

For those who have cash on hand, wait. And be more attentive to historical operational metrics. And, for those just starting out, the market remains more favorable to the entrepreneur than to the investor. Good entrepreneurs choose where they raise: if they want to raise with me, with Kaszek , with monashees or with Andreessen Horowitz . 

Are Brazilian entrepreneurs more prepared for this journey? 

The quality of the players is incomparable. Obviously you've always had Garrinchas and Pelés (Brazilian soccer stars), but the physical preparation of the Ronaldos  today is incomparable to the Pelés of 10 years ago. They are prepared in every possible and imaginable aspect, such as team, products, and fundraising . They are professional franchises . 

Astella started in 2010, when the bush was high. Despite this low tide scenario, has the Brazilian market advanced in recent years? 

The joke we make is that back in 2010 we played lowland soccer with a sock ball. Now we are in UEFA (the European football league) 

Aren't we playing the Brazilian tournament anymore? 

We've passed. We're talking about creating global companies. 

Is the investment outlook for Latin America better than for Asia, Europe and the United States, even because it is a more recent market? 

There is an economic notion of investment called sharpe ratio, which is the ratio between risk and return. If we could say that there is a sharpe ratio for different ecosystems, that of Brazilian venture capital is very good. Although it had this exuberance last year, it represents no more than 0.2% of GDP. Last year, the US venture capital industry hit 0.8% of GDP. Comparing the size of the savings, there is still plenty of room for private money and early stage in Brazil. I would say that, if I could compare, the Brazilian casino is smaller than the American one, but it is easier for you to go home with money.

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You can read the article in portugues at:  "O conselho de Edson Rigonatti, da Astella, aos empreendedores: preservem o caixa" at: https://neofeed.com.br/blog/home/o-conselho-de-edson-rigonatti-da-astella-aos-empreendedores-preservem-o-caixa/

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