It’s no secret that the economy has cooled off recently, especially in the tech sector. And while it’s showing signs of a modest recovery, there’s still going to be a long road ahead until we see another boom period like we did in 2021. In the meantime, many startups are still having trouble getting funding from venture capitalists—which is a problem because VC is typically the go-to source of funding for most SaaS startups.
This leaves startups in an uncomfortable place. Many founders are wondering what exactly happened to all the VC funding that was so abundant just a couple of years ago, and how they’re meant to keep their businesses afloat without it.
Well, there’s actually a word for what happened: Zombie VCs. Zombie VCs are venture capital firms that have enough money to stay in business, but not enough to take on new investments. They occur every time there’s a downturn, and cause many problems for startups that are trying to secure their next big funding round, or to get their business off the ground in the first place.
Keep reading to learn more about zombie VCs, how they impact startups, and how alternative financing options can help you keep your business funded without needing the help of venture capital.
Understanding zombie VCs: A silent crisis for startups
Zombie VC is an informal term to describe any venture capital firm that is still in operation but lacks the necessary capital to invest in new startups. While they still take care of their existing investments, they’re typically barely scraping by, with just enough capital to cover existing operating costs and to service their debts. And sometimes they don’t even have that.
Zombie VCs may or may not agree to give more funding to companies already in their portfolio, and in many cases, even if they do offer new funding rounds, they’re significantly smaller than expected and may involve extra stipulations. But, one thing’s for sure: they’re not open to investing in a new company, no matter how groundbreaking its product is.
Why do zombie VCs exist?
Zombie VCs, like zombie companies of all kinds (broadly defined as any company in any sector that still generates cash but is heavily burdened by debt), are a product of recessions, downturns, and other times of economic weakness.
Zombie VCs occur because of a network of interdependent factors that are all linked to poor economic performance. Some of these factors include:
- High interest rates. Most venture capital firms borrow significant portions of their money. High interest rates increase their borrowing costs and their debt burden on existing debts. This limits the total amount of capital they have to invest.
- Limited fundraising options. When the economy is weak, limited partners (LPs) may become more risk-averse and hesitant to commit new capital to venture capital firms. This makes it difficult for VCs to raise additional funds, resulting in a funding gap and potential reliance on existing capital to sustain operations.
- High debt burdens. Some venture capital firms may carry significant debt burdens, either due to financing their operations or supporting their portfolio companies. When economic conditions deteriorate, the pressure to service debt can become burdensome, limiting the firm's ability to invest and generate returns.
- Decreased return on existing investments. As the economy cools down, a VC firm’s existing investments may have significantly lower performance compared to the projections the firm had when it initially invested. As a result, the firm may hold on to the investment without exiting for much longer than planned, or sell the investment without making a profit. This can have a significant impact on the firm’s available capital to make new investments.
Consequences of zombie VCs
According to BusinessNews, zombie VCs aren’t going away any time soon—in fact, they’re likely to increase. Global Entrepreneur Malye Gavette, CEO of Network Techstars said that the number of zombie VCs is likely to increase by 50% over the next several years, at least if the economy continues in a downward direction.
The biggest consequence of this on hopeful startup founders is that VC funding will get harder and harder to secure, for both young and mature startups. A VC that previously funded you may refuse to fund your next round, or may offer significantly less money than you need. Startup leaders will have to get more savvy about preserving their cash runway and exploring the types of alternative financing options they have available that could act as a supplement or substitute for venture capital.
How alternative financing can help
While venture capital has long been the most well-known source of funding for startups, it’s not the only option. And while many VC firms may be closing their doors for now, many alternative financing providers are more than willing to accept new companies.
Many alternative financing providers also allow startups greater flexibility and control over their funding. Unlike traditional venture capital, alternative financing methods are not solely focused on equity. Instead, they encompass a range of financing models that can be tailored to suit the specific needs and goals of your startup.
By exploring alternative financing options such as revenue-based financing, venture debt, or even crowdfunding, SaaS startup owners can gain access to the capital they need to fuel their startup's growth and development.
Types of alternative financing options for SaaS B2B startups
So what kind of alternative financing options are available? Here is a brief overview of some of the most notable ones, how they work, and who they’re best for. For more detailed information on the different options for funding your startup, both alternative and traditional, check out this article.
Revenue-based financing, or RBF, involves securing funding in exchange for a percentage of future revenue. It doesn’t involve taking on debt or giving up equity, and the amount of capital you have access to is typically based on your current ARR.
Because of this, RBF is a good option for mid-stage startups that have started bringing in regular revenue for a few months or years and have the financial records to prove it. It offers flexibility and allows startup leaders to repay the funding based on their business's performance. However, it doesn’t allow you to access as much capital as you would from a venture capital firm.
Debt financing involves obtaining a loan that must be repaid over a specified period with interest. It can be an attractive option for startups with a steady revenue stream or valuable assets that could be used as collateral.
Debt financing can be obtained through traditional lenders or venture capital firms. Traditional lenders typically offer lower interest rates, but require more collateral and requirements for approval, like a good credit rating. Venture debt, on the other hand, comes with higher interest rates, and bases approval decisions on the potential of your business and other similar criteria to what venture capital involves.
Crowdfunding enables startups to raise capital from a large pool of individuals, typically through online platforms. It offers the advantage of allowing you to engage and mobilize a community of supporters while securing funding. Because of this community element, crowdfunding can also serve as a marketing tool or even a testing tool, generating early traction and validation.
Crowdfunding has historically been most popular among seed-stage or early-stage startups that are trying to get their businesses off the ground since it’s often the only accessible form of funding available to these businesses. Because of this reputation as a beginner’s tool, it might not be wise for your brand image to use as a mid- or late-stage startup. It also requires creating a compelling value proposition and effective marketing efforts to stand out among the crowd, making it difficult to pull off.
Peer-to-peer lending, or P2P lending, connects startups directly with individual investors through online platforms. These investors can lend funds via a variety of methods, but the most popular methods are debt-based loans and crowdfunding-type funding that rely on repayment through either interest or equity.
The main benefit of P2P lending is that it eliminates the need for traditional financial intermediaries like banks and makes the lending process quicker and more accessible. P2P lending can also offer lower interest rates than typical debt financing. However, it may require a strong credit profile and can carry the risk of dealing with individual lenders instead of institutional entities.
Tips to navigate the land of the living dead
Whether you decide to pursue VC funding anyway or opt for alternative financing options, navigating the funding landscape in the era of zombie VCs requires careful consideration and strategic decision-making. Here are some practical steps to help you make the right decisions.
- Assess specific financial needs and goals. Ensure you know the specifics of the amount of funding required, the purpose of the funds, and the desired timeline for securing the capital. This will help you organize your efforts and stay on track.
- Research and explore different alternative financing options. While I listed a few of the most popular alternative financing options, it is by no means an exhaustive list. Take the time to examine all your options to determine which one suits your needs the best.
- Evaluate the reputation and credibility of potential financing partners. Once you’ve decided on what financing option you want to use, don’t just apply to any lender. Evaluate the reputation, credibility, and requirements of all your potential financing partners to determine if they’re a good fit. You can do this by choosing established lenders, reading reviews, and assessing their expertise during sales calls.
- Carefully review and understand the terms of your agreement. Before committing to any financing arrangement, carefully review and understand the terms to ensure you’re willing to commit to them. Pay close attention to interest rates, repayment terms, collateral requirements, and any associated fees or penalties. Seek legal or financial advice if needed to ensure you have a clear understanding of the agreement and its implications.
- Look for flexibility in repayment options. Flexibility in repayment options can be crucial for startups, especially during periods of growth and uncertainty. Look for financing partners that offer flexible repayment structures, such as revenue-based repayments that align with your business's cash flow. This can provide breathing room and help manage financial obligations while you focus on scaling your startup.
- Understand the application and approval process. Each alternative financing option may have its own application and approval process. Understand the requirements, documentation, and timelines involved. Be prepared to provide necessary financial and business information, such as revenue projections, business plans, and historical performance data. Knowing the process in advance will help you streamline your application and increase your chances of securing the funding you need.
- Seek transparency and clear communication from your financing partner. Seek partners who are open and transparent about their terms, processes, and expectations. Establish clear lines of communication to address any concerns or questions that may arise throughout the financing journey.
Capchase Grow: A viable solution in the age of zombie VCs
If you’re looking to fund your startup without having to compete for the attention of the few venture capital firms that are still taking on new companies, consider Capchase Grow.
Capchase Grow is a revenue-based financing solution that allows you to quickly access funding based on your existing ARR. Within just 3 days, you could get approved and have the funds you need to scale your business and cover operational expenses deposited in your bank account. With flexible repayment terms based on your recurring revenue, it involves no debt, no loss in equity, and no hoops to jump through.