Taking stock of the venture capital market in 2023, it’s clear to see that we’re in a transition point. For the past 10 years, with interest rates near zero, VC investors plowed record amounts into tech startups and enjoyed a seemingly ‘easy’ investing environment. Prices went up from round to round, and startups were encouraged to grow, grow, grow, and not to worry about profitability. It’s safe to say that that era is now over. And young investors who left careers in banking or consulting to enter venture feel disillusioned – they didn’t think it would be this hard.
What’s going on in Venture of Q1 2023
According to the latest Preqin report, Q4 2022 was one of the worst quarters in terms of venture capital fundraising in 9 years.
- Q4 slump: Venture firms raised $20.6 billion in new funds in the fourth quarter. That was a 65% drop from the year-earlier quarter and the lowest fourth-quarter amount since 2013
- Fundraising slowdown: LPs invested in 226 VC funds in Q4. By contrast, they backed 620 funds in the last three months of 2021
- First time fund managers hit hard: In 2022, limited partners backed 141 funds run by first-time managers, a 59% decline from the prior year and the lowest number since 2013
How does the constrained LP environment manifest for funds and startups?
- Despite “record dry powder” VCs aren’t deploying, especially in growth stages
- The fundraising environment is constrained especially for emerging managers (fund 1,2,3)
- Many LPs are dealing with legacy portfolios and funds that blew up in size and need to adjust to the new reality
Even though the numbers may seem bleak now, I think there’s a huge opportunity in this market. Especially for small funds like ours (Remagine Ventures) to invest in top talent that’s becoming available (for various reasons: layoffs, leaving unicorn companies, new tech creates new opportunities, etc) and are looking to build their companies based on fundamentals, from the ground up, starting from prices that more in line with today’s market.
In today’s market, I believe small is beautiful, and that specialisation matters. Most founders reported (in several different surveys) that knowledge and belief in their industry/sector and personal connection is one of the key reasons they would choose one investor over another. See the recent reports by Frontline Ventures and Creandum on what makes founders choose one offer over another.
Don’t just take it from me. This is what an institutional investor was quoted (anonymously) in the latest Emerging Mangers report by Vauban:
We identified what performs best – and that’s small funds. Essentially, show that you can build a great portfolio and deploy all capital pre series A.”
-Institutional investor (anonymous)
I agree with Vijen Patel that 2023 might be one of the best VC seed Vintages but most institutional LPs are standing on the sidelines. It’s time to build, and take venture back to basics: helping founders build large sustainable companies. Support emerging managers.
Another similar sentiment came from one of the most transparent (and successful) venture investors, Josh Wolfe of Lux Capital. In his Q4 memo to LPs he elaborated on the state of the market and said:
“… future returns from funds deployed in 2023 and 2024 vintage years, with declining entry prices and more orthogonal investment strategies, may prove to be the very best in nearly a generation”
Josh Wolfe, Lux Capital
I gave my two cents on this environment in the 2023 VC Survey by Calcalist in December 2022. This is what I said then (and I stand by it)
2023 is likely to be a tough year on the macro level, but I truly believe it’s a great time to start new companies. Seed and pre-Seed investment levels and valuations remain healthy, there’s more talent in the market and less competition. From a technology point of view, new tech tools like generative AI means that tasks can be accomplished with fewer resources and at a higher speed. Founders would be wise to take advantage of their key benefits of being a startup: speed and innovation.
Eze Vidra, Remagine Ventures
Venture remains attractive but LPs have been burnt
With a 11.5% IRR (on average) over a 15-year horizon, Venture continues to outperform other long-term asset classes. Maybe surprisingly, but emerging managers in particular, outperformed ‘blue chip’ funds from 2004 to 2020.
However, many LPs are suffering from VC performance anxiety. They are more reluctant to deploy capital or, at least, not without extensive and reinforced due diligence. Some funds have been deploying capital too quickly, with little to no diligence, and at inflated prices that will not stand in the current market.
The result is mass layoffs (over 119,000 in the US since the beginning of 2023 and it’s only Feb), down rounds (even for Silicon Valley darlings like Stripe) and fund terms that go above the 2/20 standard. Gil Dibner captured that sentiment in a recent Twitter thread:
So where can LPs find relative “stability” in this market? According to Samir Kaji, I love that we hit 2 out of 3 criteria (as a small, pre-seed, specialist fund)
I hope LPs, emerging managers and startup founders can rise up to the occasion and go back to the grass roots of this asset class. Supporting innovators in bringing cutting edge products, powered by technology, to solve society’s biggest needs. Kudos to all the emerging managers and early stage founders, who are out there and continue to grind against the odds. Luck favours the bold!