VC Market Update

In the past 5 years, the VC market has undergone some significant shifts impacting how easy it is for founders in different industries to raise capital.

Prior to the pandemic, capital was flowing at an unprecedented rate in the tech industry with seed capital being relatively easy to acquire if you could build a product and acquire the first few customers to prove product/market fit without funding.

When the pandemic started, capital stopped flowing, like in public markets; however, this was temporary, and within 6-12 months, markets had recovered and were doing even better than before. At this stage, companies were raising with just an idea/presentation; there was a sense that the pandemic had accelerated tech adoption, and this would create huge opportunities for startups.

Fast forward to late 2022 and interest rate hikes, along with a lack of capital being injected into VC firms as LPs await the exits from 2017-2021 investments, there was a considerable decline in investment and the bar was raised much higher for attaining your early capital.

Now again, we find ourselves in a new financial market, so let’s discuss what the market looks like today.

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There are a few major trends that are driving the VC market today but I want to focus on two of the biggest; AI and Startup Exits.

AI

AI saw a massive surge in investment in late 2022 and early 2023 as the rest of the market was declining. The launch of Chat GPT demonstrated to general public the potential of Generative AI and led many investors to believe that SaaS companies with inbuild Generative AI could be the next wave of startups similar to the wave seen from 2004-2008 during the SaaS and Social Media boom.

Since then, the tone of AI has actually shifted to investing primarily in defensible technologies. Investors realized that just building a SaaS product that uses ChatGPT wasn’t unique, and anyone could easily copy your product. Now they focus on investing in AI, where companies are actually building their own models or have some proprietary data that they can leverage to make a base model more effective. This is why we are seeing more concentrated large investments in the AI industry and less small investments in early stage ideas.

The final impact AI is having on the market is that it’s making the bar much higher for all startups. The reality is that with Generative AI, investors now understand that building products is easy. it’s not 2005 where you needed specific skills that a very small percentage of people had; coding talent is widespread, and AI can help most people build very basic apps. What is now valuable is distribution. VCs are looking for companies with strong distribution, to prove this you often need a product in the market already. This is a new hurdle most startups need to clear.

Startup Exits

For a long time there were two trends that kept cash flowing in the VC Market, (i) Big Tech acquisitions, (ii) IPOs.

Companies like Meta and Google have long liked to buy up talent for acquisitions. We’ve all heard the jokes about people who were acqui-hired by Google, sat around collecting a paycheck and eating free food for years, and then left when their equity vested. These companies aren’t taking that approach anymore; many of them have fired top talent. They are no longer scared of competition from startups and won’t just buy up companies to own their talent. (When they do, it's now for very strategic reasons, and they have even started just hiring away Founders/CEOs from their own startups instead of acquiring the company). This has removed a whole flow of cash that used to go from these big tech companies to VCs and back to LPs. The lack of cash flowing back to LPs means they can’t re-invest in funds meaning there is less money available for new startups.

IPOs are also a huge part of the equation. Recently, we’ve seen many tech IPOs fail or underperform; this has meant that less public money is going into buyout VCs from their positions and putting liquidity into the startup market.

State of the Market

The end result of all of this is that there is less money going into VC firms right now and less money being deployed by VCs, making it harder to raise. This is even more difficult for non-tech founders, given the near requirement for a product at this point to raise, and for those outside the AI industry where most investment is still focused.

Overall, the bar is higher, the stage of the first raise later and the timescales much longer.

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