Financing a startup through the 2022 rate cycle

As US interest rates rose, venture financing required a closer account of cash use, financing assumptions and the time needed to prove the commercial case.

Capital markets4 min read

Federal Reserve headquarters, Washington, D.C.AgnosticPreachersKid · CC BY-SA 3.0

On 16 March 2022, the Federal Reserve raised the target range for the federal funds rate to 0.25–0.50 percent and said further increases would be appropriate. Inflation was already elevated, reflecting pandemic related imbalances, energy prices and broader pressures. The invasion of Ukraine added uncertainty and further inflation risk. The decision marked the beginning of a tightening cycle whose eventual size was not yet known.

For a startup, the announcement did not mechanically change the value of its technology or customer relationships. It changed the financial setting in which those assets would be funded. Capital providers could earn more from lower risk alternatives, debt could become more expensive, and cash flows expected far in the future became more sensitive to the return an investor required. Time to commercial progress acquired a higher financial cost.

A modest first step became a substantial tightening

The target range reached 1.50–1.75 percent in June and 4.25–4.50 percent in December. The scale of that tightening was not evident when the first increase was announced. Financing assumptions could move substantially within the period covered by an annual operating plan.

Selected 2022 Federal Reserve decisions

Period or category	%
16 March	0.5
15 June	1.75
14 December	4.5

Upper bound of the federal funds target range after each selected announcement. These are three decision dates, not the complete sequence of 2022 increases.

Sources1 2 3

The Federal Reserve's subsequent Financial Stability Report attributed substantially tighter financial conditions to higher rates, a weaker outlook and elevated uncertainty. It also described falling financial asset prices and increased volatility. The report documented a broader repricing of risk; it did not isolate the causes of any individual company's financing or demand problems. Business quality and sector conditions still mattered.

Long development periods required more explicit financing assumptions

An investor valuing future cash flows discounts them to reflect time and risk. If the required return increases while those cash flows remain unchanged, their present value falls. The effect can be greater when much of the expected value sits far in the future. This explains part of the sensitivity of growth businesses without reducing venture investing to a public market valuation model.

An aerial view of the TSMC Fab 21 construction site in the Arizona desert, with cranes around large industrial buildings. — TSMC Fab 21 under construction, Phoenix, Arizona, November 2023.Hunter Trick (TrickHunter) (opens in a new tab) · CC BY-SA 4.0 (opens in a new tab)

For a semiconductor or industrial technology company, the practical concern was the sequence of financing before material revenue. Product development, qualification and customer integration could each require capital. A plan that assumed an easy round after every technical milestone needed a second case in which financing took longer, arrived at a lower valuation, or required stronger customer evidence. The engineering schedule and the financing schedule could no longer be reviewed independently.

This also affected the interpretation of progress. A technically impressive milestone might leave the central commercial uncertainty unresolved. Management needed to distinguish what another quarter of spending would demonstrate: manufacturability, customer acceptance, repeatable installation or an order with credible payment terms. That distinction made it possible to compare different uses of scarce capital.

Runway depended on cash that could actually be used

Dividing a bank balance by a recent month's cash burn offers a rough estimate. It misses committed equipment purchases, annual software bills, debt service and uneven customer collections. A business could report growing contracted revenue while using more cash to fulfil it. Hardware inventory and customer payment terms made that gap especially important, but implementation spending and delayed enterprise procurement could create similar pressure in software.

A more useful forecast separated cash already available from receipts that depended on a customer decision. It showed the effect of slower collections and the expenditure required to meet signed commitments. It also identified when hiring or expansion plans would need to change to preserve cash. Decisions made early could preserve options that were expensive or unavailable once payroll and delivery obligations became urgent.

Borrowing deserved separate treatment. Floating interest charges, repayment dates and financial covenants could alter the cash forecast even when the original facility appeared inexpensive. New debt did not solve a funding gap if servicing it depended on an uncommitted equity round. The relevant question was whether the business could meet its obligations under a plausible delay in financing.

Cost decisions had to preserve commercial progress

A uniform reduction across every department can lengthen a cash forecast while delaying the work needed to finance the company. Cutting customer implementation support may protect this quarter's spending but postpone reference deployments. Deferring a necessary reliability test can leave an unresolved obstacle to procurement. The connection between an expense and the next commercial decision is more informative than its departmental label.

Boards therefore had reason to scrutinise the milestones attached to the remaining capital. Which expenditure could be deferred without changing the customer's decision? Which experiment could invalidate the plan early? Which signed order required more cash than it would initially generate? An operating plan built around those questions could preserve essential development work while reducing the company's dependence on the timing and terms of its next financing.

Investment implications

A policy rate is one input into financing conditions, rather than a direct venture valuation formula.
Cash forecasts need to include collection delays, commitments and the possibility of a later financing round.
Capital discipline should protect the work that resolves commercial or technical uncertainty.