2022 – A Changing Venture Capital Landscape
For years, the trajectory of the venture capital industry saw nothing but growth, with 2021 generating close to $775B in exit value. 2022 is a contradictory reality check. The unfolding of high inflation, rising interest rates, and volatile geopolitical conflicts abroad has led to economies struggling to maintain growth, with no promising outlook for the next couple of years. The startup ecosystem as a result has seen a large drop in venture funding, down 50% from this time a year ago. A bevy of investors are choosing to act cautiously through temporary inaction, sitting on $572B in total dry powder in anticipation of more favorable market conditions. An industry-wide shift of expectations in the fund-startup relationship is currently underway, favoring a more grounded investing approach. Here are three changes influenced by the recessionary market conditions.
The Return to Fundamentals
Firstly, the focus on ‘growth-at-all-costs’ is becoming much less popular, especially as the amount of bridge, extension, and down rounds is increasing. Many startups with lofty valuations must now face the reality of reassessing their worth as they attempt to manage their dwindling runways. For new investments, investors are now in search of fundamentals: capital efficiency, customer retention, and conservative growth forecasts. If a startup demonstrates discipline in managing its cash inflows and outflows, fully understands and is exploring its target market, and sets targets for profitability that are equally ambitious but achievable, it can confidently navigate this market contraction while maintaining continuous growth, prospering once favorable conditions return.
A Focus on Resilience
Next, the top-performing startups of tomorrow will be those that show resilience. For early-stage companies, resilience is tied partly to the founder’s ability to execute on company-wide milestones that include hiring and nurturing complementary talent, achieving product-market fit, raising sales and earnings margins, and implementing agile operational processes. Moreover, investors are attracted to founders who, in addition to their past and current performance, are mission-driven and aren’t shy to confront unprecedented challenges or difficult decisions that affect the company’s positioning.
Investors that Favor the Performers
Lastly, the dynamic between funds and startups is set to be more lopsided. Because of the ongoing decrease in venture capital being deployed, investors are choosing to engage with fewer startups throughout the year. A top-performing startup is likely to see an increase in the competition between funds in the early stages, resulting in the availability of more favorable terms from a selection of funds, but companies that are yet to reach any paying customers or are struggling to initially expand will see their fundraising timelines extend by several months.
2022 was a tumultuous year for venture capital, but we see the next few years as an incredible opportunity to strategically invest in startups that share advanced and foundational technologies meant to flourish in the long term, complete with strong fundamentals, a clear path to sustainable and profitable growth and a differentiated value generating approach. To us, defensibility in this market is king, and we share an interest in supporting startups that are largely IP-driven, are progressing towards establishing an early product moat, and demonstrate ‘stickiness’ with high rates of customer retention. These startups are more likely to see valuations that reflect current company performance, not exit potential, and will be drawn to dealing with strategically aligned investors to solidify their sustainable competitive advantage.