Hey Insiders! I hope everyone is having a wonderful holiday season. Vibha and I recapped the 10 biggest venture capital trends for 2022 in Wednesday's issue. In today's issue, we have highlighted our predictions for the VC industry as we head into 2023. We want to thank the readers for their continued support and wish everyone a Happy New Year! | |  Karan | |
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Venture funding winter will likely continue into 2023, as venture firms will wait for the IPO window to open up, the inflation rate to be brought under control, and market conditions to improve before matching 2021’s level of investments. Gordon Ritter, a founder and general partner at Emergence Capital Partners, estimates that venture funding winter could end by 2025. He points to the earlier venture funding slumps after the dot-com bust and 2008 financial crisis that took two to three years before investors started investing for growth. Optimistic estimates point to a recovery from the second half of 2023. Regardless, these difficult economic times have historically produced exceptional startups, per Kevin Brennan of Anter VC. More: - According to Brennan, the venture funding drought shows no signs of easing.
- However, venture funds have a record $572M in dry powder available globally for deployment, of which U.S.-based venture firms have $290B.
- Brennan adds that despite the volatility in funding, 2022 had many new technological innovations, which points that the technology sector should be back to its funding normal soon, likely driven by early-stage investments.
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Seed-stage investment remained strong in 2022 and will continue to be the key area of focus for venture firms going into 2023. Seed-stage investments are crucial for venture firms as it provides an opportunity to grab more equity at lower valuations that can likely provide much higher returns than investing in later stages. While seed-stage and early-stage investments are riskier, venture capitalists have a high amount of dry powder capital available for deployment. They will likely play the long game in hopes of maximizing returns. More: - A Morgan Creek study analyzed the venture fund performance after the 2008 financial crisis and found that early-stage funds significantly outperformed later-stage funds after emerging from the economic downturn.
- Investors know that the best years of venture funding are just after periods of recessions. The down periods give them time to perform due diligence on their investments and carefully make their investments at low valuations.
- Data from Pitchbook’s Q3 2022 Venture Monitor shows that seed-stage funding showed resilience to the venture capital dip and remained at 2021’s levels.
- Median pre-money valuations in Q3 were $10.5M, matching the levels of Q1 and Q2 2022.
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Cash-rich firms will likely merge with or acquire startups running out of cash in 2023. As valuations continue to decline and stabilize, the market appetite for deal-making is expected to pick up. More: - A study by Ernst & Young found that 72% of tech CEO respondents are planning to pursue M&A in the next 12 months.
- A total of $1.42T worth of U.S. mergers was announced in the year through Nov. 29, per Dealogic — a sharp decline from 2021’s $2.74T. “Market uncertainty is the death of deal-making,” noted Jonathan Levitsky, a partner working on tech M&A deals for law firm Debevoise & Plimpton.
- According to an Insider report, industry chatter indicates that investors across different sectors expect more M&A in 2023. In 2022, mergers and acquisitions recorded their worst year since 2017, with rising interest rates, inflation, and a looming recession.
- Additionally, as central banks around the world continue rate hikes, startups are anticipated to struggle. As the cost of deal financing increases, 2023 could see an increase in distressed M&A.
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In 2023, the job market is expected to be flooded with individuals who will explore jobs with lesser salaries at startups or smaller firms from different sectors. Startups, which have typically found it difficult to recruit top talent, may be able to tap the tech talent available due to recent layoffs and entice potential hires with ESOPs. In the U.S., 76,835 people were laid off in November alone, nearly double the previous month. More: - Lee Moser, Managing Partner and Founder of AnD Ventures, expects to witness more tech layoffs in 2023, which will inevitably allow HR to "smart hunt" for young startups that have struggled to find talent with average salaries. Itamar Weizman, partner and head of climate investments at Firstime Ventures, also holds the same view.
- Tech companies like Amazon, Google, Meta, and Twitter announced a reduction in force (RIF) this year.
- Sachin Gupta, CEO of HackerEarth, notes employees recently laid off "will naturally" explore other sectors like consumer goods, banking, and hardware and engineering, as these sectors are not slowing down while tech hiring slows.
- The U.S. Department of Veteran Affairs announced vacant positions for designers, engineers, and cybersecurity. Kurt DelBene, chief information officer, expects to hire people laid off from Meta, Google, and Twitter for these positions.
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U.S.-based seed-stage and early-stage startup valuations remained higher than 2021's levels in 2022. While valuations might take a small hit in 2023, they will remain robust and likely match 2021's levels. Investors' appetite for early-stage deals remained high at the end of Q3 2022, with the demand for such deals remaining at 1.4 times the capital invested by VCs. More: - Late-stage firms were seeking investments from investors, but VCs were unwilling to invest, with the demand-to-capital allocation ratio rising to 3.5.
- Valuations of late-stage startups will drop as they start focusing on cash conservation and profitability rather than growth.
- Late-stage startups, especially Series C and Series D startups running low on cash reserves, will likely raise down rounds and face significant valuation cuts going into next year.
- Early-stage startups were valued at 3.3 times their revenue multiples at the start of 2022 and were valued at 2.4x by the end of Q3 2022.
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Venture debt funding increased by 7.5% in the first half of the year, as equity funding dwindled by 8% in the same period. The trend is expected to continue into 2023, as more startups will start exhausting their cash reserves. Due to the mismatch of valuation expectations between startup founders and investors, more startups will turn to non-dilutive financing options like venture debt in 2023. More: - Venture debt offers founders the chance to founders to avoid raising down rounds and keep the valuations of their previous fundraising.
- However, debt financing comes at a cost, typically averaging a 9% to 10% coupon rate, per Bloomberg.
- Adding debt could also impact profitability and the ability to raise future funding.
- Meanwhile, structured financing deals are increasing in startups that have shelved their IPO plans and want to avoid down rounds.
- They are enticing investors with warrants, additional dividends, and preferred shares.
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Startups are turning to debt-focused deals like bridge loans, structured equity, and convertible notes to avoid a down round. While the market continues to battle interest rates and inflation, it is likely that pre-IPO firms will turn to bridge financing to curb equity dilution from a down round and ensure business sustainability until IPO plans materialize. More: - Initial public offerings (IPOs) declined to the lowest level since 2009, halting a vital fundraising source for mature private companies.
- The cyber security firm, Arctic Wolf, valued at $4.3B, raised a $400M convertible note in October. The debt financing was twice as much as its largest equity financing.
- Public equity focussed firms like Coatue Management and Viking Global Investors are now raising funds to invest in structured equity deals with startups.
- Over $250B of high-grade term loans were sold this year, per Bloomberg league table data.
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The U.S. introduced three key policy initiatives, namely the Bipartisan Infrastructure Package, the CHIPS and Science Act, and the Inflation Reduction Act. These three policy decisions are set to incentivize venture capitalists' participation and will likely start bearing fruit from next year onwards. The U.S. government is currently considering additional considerations to tip regulations in VCs' favor to make it easier for them to invest in startups. More: - This year, the U.S. Treasury Department started transferring the amount sanctioned to respective states under the State Small Business Credit Initiatives (SSBCI).
- The program is a $10B one and is part of the $1.9T American Rescue Plan Act.
- States are using the funds to provide venture capital and accelerator funds to startups.
- The U.S. Treasury approved SSBCI plans worth $940M for nine states in July and $740M for four states in August.
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In 2022, the post-pandemic biotech market witnessed breakthroughs in precision medicine, gene sequencing, and agriculture biotech, among others. As valuations decline with advancements in science, biotechnology funding is expected to pick up in 2023. More: - Technological advancement has also contributed to faster Food and Drug Administration approvals. According to Statista, between 2017 to 2021, the lowest number of drugs approved was 46, and the highest was 59. The ratio was 22 and 46 between 2012 and 2017.
- With biotech firms using AI, big data, and analytics to interpret data, gene sequencing and gene editing technologies enables companies to understand genomes for mass adoption.
Zoom Out: - The robotics industry also witnessed significant developments, especially for applications in agriculture and warehouses.
- OpenAI’s Dall-E and ChatGPT also revealed possible utilities of artificial intelligence in the future.
- In 2023, both sectors will likely be heavily funded as the commercial use of robots and AI seems within reach.
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With an uptick in regulations, DE&I initiatives will likely remain a top priority for investors in 2023. In April 2022, regulators in the U.K. announced at least 40% of the board should be women, and one member of non-white ethnic minority background should be in a decision-making role. More: - The European Parliament and Financial Conduct Authority introduced a law requiring all European list companies to have a minimum of 40% women on their boards by 2026.
- Investors will push for DE&I to make sure companies are compliant with regulations, predicts Nicole Wiley, CEO and chief development officer at 100 Women in Finance and former COO at Morgan Stanley.
- A panel of industry experts from Coca-Cola, Axis Agency, NBCUniversal Media, and Principal Financial Group agreed that despite tough times it would be irresponsible to stop investing in DE&I, stating that organizational investments driven by DE&I can create a positive impact on the bottom line.
- “Investors have realized that companies often have the top of the firm sorted, but are now asking what the rest of the organization looks like,” as long-term investors want to see who will be leading the firms in the next 10 or 20 years, said Wiley.
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- January 31 - Growth Summit 2023 (Register Here)
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 |  | Karan Chafekar is a Management Consultant, Business enthusiast, and Licensed Pilot.
Vibha Chapparike is a Freelance Writer & Editor at Inside.com. With her post-graduation in Management and Finance completed, Vibha is expanding her knowledge in venture capital, business, startups, and technology. She has had a career in public relations and communications. | | | | Editor | Aaron Crutchfield is based in the high desert of California. Over the last two decades, he has spent time writing and editing at various local newspapers and defense contractors in California. When he's not working, he can often be found looking at the latest memes with his kids or working on his 1962 and 1972 Fords. | |
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