What Will VC Investment Look Like in the Year Ahead?

The crises of 2022, which came in the form of geopolitical instability, economic recession, and inflation, have taken a toll on the venture capital investment market, which now has to function in an extremely unpredictable and volatile environment. This comes as a heavy blow for investors and founders alike, especially after 2021, a very prolific year that saw a surge in VC deals, exits, and valuations. As VC investors now exercise increased caution in closing financing deals, global VC funding volumes plummeted by almost 60% compared to Q4 in 2021. While VC investment levels will certainly take time to bounce back, and the economic uncertainty persists, it is nonetheless worth exploring new VC funding trends for 2023 to shed light on where to search for opportunities and promising deals in the upcoming year. 

When uncertainty and change become a new reality, one’s natural response is to seek stability and predictability. This is the attitude with which VC funds approach investment deals now, transitioning from short-term investment strategies to a more conservative long-term perspective with a focus on stable, reasonable growth. Investors choose to play it safe, opting for a later stage of financing as well as turning their eyes to companies with high-impact propositions and demonstrated financial resilience. 

Previously, startups could hope to secure a sizable seed-round investment from a VC firm provided that the founders had a solid pitch deck that demonstrated certain traction and the ability of the company to execute on the projected targets and achieve exponential growth. Companies could expect to raise seed rounds with a valuation of as much as $5 or even $10 million, while they were judged almost exclusively by their potential in terms of strategy, vision, business model, market size, product market fit, and the competitive landscape, which is the key deciding factor. Building up credibility and delivering a persuasive pitch is still an effort-consuming task; however, once investors were presented with a viable business plan and convinced, they were ready to offer generous funding. Maximising a company’s initial valuation brought about benefits for both the founders and the venture capitalists. With more capital to burn, companies achieve higher growth rates and can thus increase their valuation dramatically prior to the next financing round, allowing the investors to turn it into their profit while also bringing the founders closer to their dream IPO or acquisition. 

Today, faced with multiple unknowns, VCs avoid making funding decisions based on promise alone, no matter how outstanding or convincing. The ability to demonstrate long-term market potential appears to be mission-critical when securing VC funding. Such potential can be proven by either the company’s financial history or the impact it is capable of creating in the long run. Investors will now be looking for companies that have demonstrated financial strength over the past year or two, paying close attention to performance metrics and balance sheets as they gauge potential investment risks and earnings. With the currently oversaturated startup market, strong financial statements and rigorous execution of performance targets create a favourable outlook for securing finance. Another deciding factor for VCs appears to be whether a company solves a pressing problem and delivers actual value. In the current economic climate, merely creating a well-made product or catering to a short-term trend is not sufficient. Businesses involved in high-impact projects in a significant market, such as cybersecurity, AI, or climate, are foreseen to continue gaining momentum and sparking investor interest. 

A continuous trend in recent years that is here to stay is the growing number of so-called unicorn startups, privately owned companies whose valuation exceeds $1 billion. The term was first used in 2013, and back then it could only apply to an exclusive minority of fewer than 50 businesses. Since then, the number of unicorns has grown exponentially, surging dramatically in 2021 when the total number of companies worth more than $1 billion surpassed their sum for the five previous years. In fact, there are private-market companies so successful that the term "unicorn" becomes insufficient to describe them; thus, enter decacorns and hectocorns, companies valued at over $10 and $100 billion, respectively. As of Q4 2022, the world counts as many as 1,200 unicorns, and the global unicorn venture market is still going strong, albeit at a more moderate pace as compared to the record-breaking 2021. 

The driving force behind the rapid growth of high-value startups is the rise of large venture capital funding rounds, or mega-deals, another recent trend in the investor market. Since 2020, the number of venture rounds worth over $100 million has seen a steady climb; in the robust year of 2021, the number of mega-rounds reached its record high of over a thousand $100-million plus deals, with five of them topping the $2 billion threshold. Despite the significant drop in 2022 global venture funding volumes compared to the previous year, its current levels continue to exceed the pre-pandemic figures, with the Q3 total mega rounds collectively accounting for $29.6 billion of investment.  At the same time, in the first three quarters of 2022, as many as 223 companies joined the unicorn ranks.  It might not seem as impressive as 2021’s addition of 390, but it is again comparable to the numbers seen in 2019 and 2020 indicating that we should still expect companies to achieve their billion-dollar-plus valuations.

Turbulent times such as these make any founder concerned with the survival of their business; startups, as emerging companies, find themselves in a particularly vulnerable position as they are typically not yet profitable and rely heavily on external funding. Founders eagerly turn to experts for advice on what course of action is best to take in order to minimise the adverse effects today’s economic downturn is yet to have on their company’s performance and growth. Controlling costs and extending the runway appear to be necessary measures that help to ensure a company stays afloat. However, as founders try to navigate the stormy waters, it is just as important that they do not lose sight of their initial ambition. 

The current changing VC landscape means startups are to experience a harder time raising capital. Without this scaffold, to survive the downturn, companies need to reshape their strategies in terms of spending, runway, and funding. Many venture capital market experts and leaders contend that a smart approach to take in challenging times is to aim to extend the runway and prioritise profitability. Essentially, founders are advised to control their burn by taking such cost-saving measures as avoiding any "nice to have" spendings and monitoring closely the return on investment for any activities and initiatives, favouring those that have near-term chances of success. As the market expects reduced round sizes, reduced valuations, and a lower number of new financings, all these steps will enable startup founders to ensure that their business survives as long as it possibly can before the crisis is reversed. From the owner’s perspective, achieving profitability seems to be sound advice; steady gains demonstrate and help establish a business’s long-term viability. 

At the same time, breaking even entails the risk of losing investors’ interest and failing to deliver on the startup’s promise. The idea of early profitability and gradual advancement is foreign to the venture capital market, where investors expect sizable returns from a business that shows high rates of growth. By resorting to a safe and steady development strategy, a startup robs itself of its ambition and falls short of VCs’ expectations. In times of crisis, it is important to exercise caution; however, it should not be done at the expense of growth. A more advisable approach for founders is to look for cost-saving opportunities elsewhere, use resources more efficiently, and optimise business processes, but still aim to increase their startup’s value.