VC Investor Pullback 2023

According to a PitchBook article posted by Jacob Robbins, the venture capital (VC) landscape in 2023 faced unprecedented challenges, significantly impacting both VCs and their portfolio companies. The tumultuous year saw the collapse of Silicon Valley Bank, a vital lifeline for startups, and a frozen IPO environment, cutting off a crucial exit strategy for investments. The latest PitchBook-NVCA Venture Monitor reveals the chilling effects of these developments, as investors pulled back, leading to a cascade of challenges for the startup market.

We had entered 2024 facing a prolonged period of challenging fundraising for VCs with not a very positive outlook. However, based on our assessment, emerging markets like MENA, India, Africa provide a new breadth of potential, while South Korea and Japan are growing significantly. Europe being quite fragmented, still provides attractive valuations. Secondaries and emerging, specialized managers will start becoming more relevant. Lastly, over the past three years we realized that VC is a local business, with the fund managers be required to be on the ground, close to the founders and active in the regional ecosystems.

The investor exodus is evident in the declining participation of crossover investors, who engage in both public and private markets. In 2023, they participated in 1,046 US VC rounds, marking a substantial 50% decline from the previous year. Various factors contributed to the retreat of crossover investors, including high interest rates, reducing their appetite for riskier investments. The strong performance of public equities further contributed to their caution, coupled with a shortage of IPOs that left their VC portfolios locked up.

The absence of crossover investors created a vacuum, intensifying competition for private capital among late-stage and growth startups. As these companies face the challenge of running out of cash runway, securing funding becomes increasingly competitive and crucial for survival.

The impact on valuations has been profound, with a dramatic fall in the creation of new unicorn companies—those valued at $1 billion or more. In 2023, only 225 new unicorns emerged, representing the lowest number since 2019. However, within this landscape, a notable trend is the dominance of AI and machine learning companies, accounting for a record-high 44.4% of all new unicorns. While VCs are relying on the existing pool of over 720 active US unicorns for returns once the IPO market reopens, analysts from PitchBook anticipate a decline in their numbers in 2024 due to challenges in going public or raising more private capital.

Despite the overall decline in unicorn creation, valuations for startups remain higher than in 2020 for most stages, except for the venture growth stage. The median valuation in this stage fell by a significant 64% from 2021 and even dipped below 2019 levels, settling at $143.5 million. This drop in valuations has forced more mature startups to resort to raising down rounds, accepting less favorable deals in an effort to survive—a trend expected to persist in 2024 as startups delayed fundraising in 2023 return to the market.

Another concerning trend is the continuation of VCs taking in more cash from Limited Partners (LPs) than they return, despite a sharp drop in fundraising. This reflects the challenges General Partners (GPs) face in liquidating their investments. The trend points towards a prolonged period of challenging fundraising in 2024, as LPs adopt a cautious approach, waiting to see returns before allocating cash to new funds.

Furthermore, LPs hitting the brakes on market participation and contributions to VC plummeting to an eight-year low could signal a shift away from generalist investing. There appears to be a growing appetite for specialized funds, particularly in areas like AI, where the demand for innovative technologies remains strong despite the broader challenges in the investment landscape.

The year 2023 proved to be exceptionally challenging for the VC ecosystem, marked by the collapse of key financial institutions, a frozen IPO market, and a subsequent investor exodus. The consequences include heightened competition for private capital, a decline in unicorn creation, pressures on valuations, and a prolonged period of challenging fundraising anticipated for 2024. Amid these challenges, specialised funds, particularly those focused on AI, emerge as potential areas of interest for investors navigating the evolving landscape.

At this stage of global economic development, VC investing becomes more critical hence financial innovation, transparency and new models will have to be adopted in order to rebuild the investors' confidence and comfort to invest in this asset class.