We believe that 2024 will be a year of re calibration for venture capital, marking a resurgence of purpose-driven investments and lasting stories. In 2022 and 2023, the VC market experienced some turbulence with as many as 25% of the companies finding valuation declines and many others facing shutdowns due to macroeconomic factors, geopolitics, and investor hesitancy. As per Pitchbook, ~2,800 VC firms out of 7,000 VC firms made less than 2 deals, although there is ~$2T private capital dry powder across private equity, private debt, private real assets waiting to be deployed in transaction. We project that interest rates will remain high and that will continue to drive valuations downward. Inflation could also remain unpredictable with its sporadic up and down movements. Additionally, geopolitical shifts will be essential to keep in mind especially the rise of the Middle East and Europe. From a venture capital perspective, this means that more LP’s will be inclined to allocate away from VC to private credit and fixed income, but this strategy would be flawed in our views. Some of the largest tech companies such as Apple, PayPal, Facebook, WhatsApp, Slack, Amazon, and Uber, were created by determined founders and confident venture investors during venture capital winters. Despite the challenging VC landscape as is commonly perceived now, we believe that this is the best time to create and invest in startups. A gradual recovery for start-up funding will come, but it is more likely to happen in 2025. But we believe 2024 will go on to be one of the best venture deployment vintages ever, particularly at the early stage. As we navigate various such dynamics, here are several re calibrations to keep in mind to read the trajectory of the venture capital landscape in 2024.
New VC Fund Raising Dynamics
In the coming year, we expect to see a rebound in VC fundraising from the lows of 2023. Although they may not hit the highs of 2020 and 2021. Many emerging managers with diverse investing backgrounds were able to raise their funds in the previous climate of easy capital. They were driven and hungry for success, but in the new environment these new managers will find it tough to raise new funds with ongoing valuation resets and in the absence of meaningful exits and distributions to LPs. In 2024, the power balance will shift more to LPs. Active GP count will fall further. We will see the great VC resignation, as many managers will realize that they won’t be able to raise new funds easily, and that the time horizon to liquidity is in the distant future. We expect to see managers across the VC stage spectrum retrenching their fundraising strategy and lowering their expectations by raising the same size—or smaller—funds than their predecessors. This shake-out will be healthy for the ecosystem, as too much money in the system contributed to the hype cycle in the first place. We are hopeful that many new fund managers will originate from existing established funds with prior existing investor relationships and execution references. This new set of fund managers will be hustling more to do better due diligence on deals that have been lacking in the presence of many tourist investors over the past several years. 2024 will also see the rise of super specialist VCs with convictions on deals and absence of FOMO mentality. With significantly less capital allocated to VC in 2023 by LPs, specialist VCs who know how to pick and price deals with discipline in this market will shine and generate outsized returns.
Re Calibration of Valuation
Although several aspects (number of startup creation, valuation, deal making speed etc.) of the VC investment landscape are improving since early 2020 during the pandemic, we think there will be more down rounds with valuations decreasing across various financing stages and higher count of startup exits to secondary funds. Except AI deals, where we think there will be some exuberance that could keep the valuations elevated to some extent. Low interest rates era created an environment of availability of cheap capital to start something new and allow easy follow-on funding and valuations to founders to experiment more freely. But many mediocre ideas that got funded in this era may not have taken shape if capital was tight. Recent high interest rates and other macro factors have lessened market enthusiasm for start-ups with mediocre ideas. Later-stage valuations are falling sharply compared to early-stage valuations. According to Pitchbook, in 2023, the median step up in valuation for follow-on financing rounds for early-stage companies was 1.7x, which is the lowest step up since 2016. A lot of startups that haven’t raised venture capital since 2022 will have to raise in 2024. We think it will bring a lot of repricing and some write-offs, as low-quality products and inefficient business model issues come to light, particularly among the Series C cohort of 2020 to 2022. Many investors have already mentally written off the losses and moved on. There will be a mass extinction event for startups. We estimate probably around 1,000 US growth stage startups will reprice, bringing pain for many founders and venture funds. But for the ecosystem, the quicker this happens the better, as it wipes the slate clean and brings valuations back down to reality, ahead of future growth and investment.
Re Calibration of Due Diligence
In hyped up frothy markets, there is a fear of missing out on potential investments when everyone is making deals at breakneck pace. Under such fast-moving circumstances, investors are lazy, and they find it easy to just follow a few trends and invest with their co-investors in popular sectors. Sometimes driven by the fear of not participating enough in the upswing and sometimes to avoid heavy due diligence work. In easier funding environments, many founders launched startups with a short- term focus, and this led to a lack of in-depth scrutiny that led to where we are today. But with valuations at a low point, investors will engage in more thorough due diligence. It creates an environment for long term visionary founders that are committed to building new things and purpose driven investors intentional about their investments, can join hands.
More Transparency for Secondary Plays
VC secondaries were active in 2023 and we will see more of that trend driven by a need for liquidity. In the absence of M&As and IPOs, secondaries will be the other exit option for VC portfolio startups and that could reset the valuation expectations further in 2024. Many large secondary funds were raised in 2023, but the secondary deals were very selective given how many startups want to exit. We further believe that only the secondary investors that are entrenched in the VC ecosystem and know the ins and outs of startup conditions will be able to access the best deals among the ‘000s of startups that will try to get their attention. Proprietary secondary transactions need transparency in how assets are performing as much as they need strong relationships with both entrepreneurs and GPs for better pricing. Many startups, having last raised capital during the venture capital boom of 2020–2022, will re-enter a transformed market in 2024 with tempered valuations, down rounds, and bridge rounds. Along with the funding winter, the environment presents an enticing opportunity to secondary investors in low credit cycles to stand the chance of securing substantial returns when some sound deals will be available at more attractive prices.
The Show Will Continue Elsewhere
Right now, AI is the central to venture community’s investment execution. The seminal breakthrough of Generative AI is sparking fervor for opportunities in it. It will surely catalyze the VC landscape and in the longer term, AI will drive disruptive innovation, but maybe not as quickly as some expect. Looking at some of the recently released 2023Q3 Burgiss private capital fundraising data, the blistering fundraising pace in 2020-2022 has helped managers accumulate a lot of dry powder. It means there is ample capital to fund transactions in 2024. Startup with latest technologies will have good prospects, but as investor appetite has shifted elsewhere, some startups may be consolidated, have their valuations reset, or simply shut down. Specifically, for startups that are operating outside the AI technology hype, we expect more late-stage companies to either fold or try to consolidate with complementary products. That’s because in 2021-2023, many such start-ups with stale technologies decreased spending and forewent growth to delay raising capital. They successfully optimized their burn rates and stretched their runways throughout 2021-2023, the year 2024 is poised to bring them back to the market for capital infusion. With shortened cash runways, we expect more companies in need of additional funding to face down round valuations.
Re Calibration of the Entrepreneurial DNA
The challenging economic and VC funding climate of 2022-2023 has sparked a shift in the DNA of entrepreneurs who will thrive in 2024 and subsequent years. In the ZIRP years of easy capital, the most successful founders were those who could pitch, charm investors, win over the media, and raise impressive funding rounds. The shortage of funding available means the most successful founders will be those who are meticulous about how they spend capital, innovate at the lowest possible cost, look for sustainable growth and a path to profitability over ‘growth at all costs. We will see rise of founders that will prioritize customers to use them as a funding source. These founders will implement rigorous financial controls to optimize cash flow, ensure prudent expenditure, and ensure to keep your burn rates low. They will make sure that they have long runways and that they are hitting those metrics. With a deep understanding of their industry and technology sectors, such founders will prefer to engage with specialist investors who are familiar with their industry.
Re Calibration of AI from Hype to Real Potential
2023 has been all about artificial intelligence (AI), specifically Generative AI and large language models (LLMs) such as ChatGPT, which launched at the end of 2022. More than one in four dollars invested in startups went to AI startups, largely driven by mega-deals such as $10B investment from Microsoft into OpenAI, and $4B from Amazon into Anthropic, which is developing the AI-powered chatbot, Claude. Most of the funding was to support the compute cost of those large models. But we think, as with past hype around Blockchain and Crypto, ‘peak hype’ for AI may well be over.
On the AI innovation front, we think usefulness of LLMs will shrink, and domain specific models trained on smaller datasets will be the choice. Proprietary AI moats of foundational model will be challenged by open-source equivalents, beginning a tectonic shift in the market. We could see the emergence of a RedHat of AI era. In 2024, we expect artificial intelligence (AI) to morph into real world use cases in various industries primarily supported by sector specific investors who will see AI as a powerful enabler and catalyst for real customer-driven solutions. We will see a reality check for AI and LLMs in general as the costs of running LLMs start to mount, along with regulations around their ethical and responsible use vis-à-vis data privacy and protection, intellectual property, corresponding lawsuits, and other issues. We will see more specific use cases for AI in healthcare diagnosis, treatment optimization, and patient management; in finance for fraud detection, algorithmic trading, and credit scoring; in manufacturing for predictive maintenance and quality control; and in addressing environmental challenges, from energy efficiency to wildlife conservation. All those use cases will be navigating the data challenge - how to access sufficient data and comply with new regulations in a way that makes these use cases viable.
/Service Ventures Team
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