Highlights from the Observation Deck #7

September 2024

This Edition of the Tech Ecosystem Watchtower shares periodic highlights on tech news and research related to the Innovation Economy being followed in the world of Venture Capital & Entrepreneurship.

What I’m Reading

Innovation Highlights:

The State of Data and AI in the Americas from the Global Data Insights Survey. Key insights reveal a strong preference for distributed data strategies across the Americas, with 78% of companies adopting this approach to better manage data gravity and enhance AI workloads. (See Image below)

Notably, the U.S. leads with 86% employing a distributed data strategy, significantly ahead of Mexico (76%), Canada (72%), and Brazil (68%). This approach is seen as critical for reducing latency and improving the accessibility of high-demand AI applications.

From a strategic perspective, IT leaders are proactively aligning their data localization with their AI strategies to optimize performance and mitigate risks, such as data breaches. The survey underscores a robust execution of IT location strategies, with 70% in the Americas, compared to 65% in Europe and APAC. This emphasis on strategic location deployment highlights the region’s leading role in shaping global data management trends, which is crucial for startups and investors focusing on infrastructure and AI-driven technologies. ( See Image Below)

The insights suggest significant investment opportunities in enhancing IT infrastructures that support AI capabilities, particularly in server and data center expansions across the region. For startups, these findings point to the critical need for robust data management solutions and localized AI services to stay competitive in a data-centric market landscape.

Key AI Issue Highlights in Articles were:

• Lack of Data Storage
• Power & Energy Demands
• Data Gravity Challenge (Realizing the value of distributed data to improve high-latency storage and processing capacity to accommodate AI workloads.)

For more details:

The state of AI in early 2024: Gen AI adoption spikes and starts to generate value

The State of Data and AI in the Americas | Digital Realty

Global Market Highlights:

Venture capital fundraising in 2024 is poised to slightly surpass 2023 levels, with current trends indicating a cautious yet consistent investment landscape. According to the latest NVCA Pitchbook report, while the total number of funds is decreasing, established managers continue to attract the lion's share of capital. As of the third quarter of 2024, established general partners (GPs) who have raised multiple funds have secured $52.9 billion, accounting for 81.2% of the year's capital. This marks the highest concentration of capital within experienced managers in the past decade.

The current investment climate, characterized by higher interest rates, demands higher returns, which influences limited partners (LPs) to favor established firms with proven track records over newer, untested funds. This trend towards capital consolidation among top-performing managers reflects a broader market hesitancy amid economic uncertainty and inflated valuations lingering from 2021. The graphic underscores this cautious fundraising trajectory, suggesting a stabilization rather than a robust resurgence in venture capital activity.

The exit market for venture capital remained subdued in the third quarter of 2024, with total exit value hitting a five-quarter low at $10.4 billion from 243 events. This period was marked by a significant downturn in high-value public listings, with only two major acquisitions surpassing the billion-dollar mark, predominantly within the biotech sector. Such exits in healthcare, although significant, are not indicative of broader market trends due to their typically longer investment horizons.

The graphic illustrates a continuing decline in both the number and value of exits, highlighting persistent market challenges such as unfavorable valuation multiples and ongoing market volatility. These conditions have amplified pressures on limited partners (LPs) seeking liquidity. With few large exits on the horizon, mergers and acquisitions, along with secondary market transactions, appear to remain the most viable exit strategies for general partners (GPs) in a sluggish exit environment.

The venture capital exit landscape in 2024 continues to highlight mergers and acquisitions as a primary exit route, with private equity firms increasingly targeting VC-backed startups for their portfolio companies. As illustrated in the graph, the share of buyouts in VC exits has remained significant, accounting for 21.8% of all exits in Q3 2024, nearly matching the previous year's levels. This trend underscores the ongoing convergence between middle market private equity firms and the venture capital sector.

However, the current buyers' market conditions in private equity contrast sharply with the sellers' market necessary for venture capitalists to realize high returns. This disparity has resulted in challenging economics for venture capitalists, particularly in securing the high double digit multiple returns traditionally sought from smaller M&A deals. As the chart indicates, the proportion of smaller exits (under $50 million) remains substantial, providing limited financial relief to venture capitalists amid a shifting exit environment.

The data from the latest PitchBook-NVCA Venture Monitor reveals a discernible trend of decreased venture capital investments as exits remain subdued. As illustrated in the graph, while investment counts have generally outstripped exit counts over the years, the ratio has notably increased since 2021, indicating fewer exits relative to the number of investments made. This pattern suggests a consolidation of venture capital into fewer, larger deals, particularly in high-growth sectors like artificial intelligence, reflecting a strategic shift towards more substantial, trend-driven investments amid a challenging exit environment.

Key Insights:

• VC Fund Concentration: Venture capital is increasingly concentrated among established managers, leading to fewer but larger deals, particularly in sectors like AI. This trend indicates a cautious investment environment where established names attract most of the funding.
• Exit Market Sluggishness: The VC exit market remains slow, with few large public listings and the majority of exits occurring through smaller M&A transactions. This sluggishness impacts the liquidity prospects for many startups.
• PE Firms' Role: Private equity firms are actively purchasing VC-backed startups as add-ons, but the buyer's market conditions are challenging VC firms' ability to achieve high returns on smaller exits, affecting the overall VC economics.
• Investment vs. Exit Dynamics: A growing gap between venture investments and exit activities suggests an environment where capital is deployed but not recouped as readily, emphasizing the importance of strategic investment choices in high-potential areas like AI to mitigate exit challenges.

Given the key insights outlined, here are specific considerations for General Partners (GPs) and tech founders in managing their businesses:

For General Partners (GPs):

1. Risk of Concentration: With capital increasingly concentrated among established funds, GPs should diversify their investment strategies to mitigate risks associated with high concentrations in specific sectors like AI. This involves balancing investments across various stages and sectors to ensure stability even if trending sectors experience a downturn.
2. Exit Strategy Evaluation: In light of the sluggish exit market, GPs should reassess their exit strategies. The current climate suggests a need for flexibility in exit timelines and mechanisms. Instead of relying solely on public listings or large M&A, consider smaller exits or alternative liquidity options like secondary sales to provide returns to LPs.
3. Engagement with PE Firms: With PE firms showing increased interest in VC-backed startups, GPs should foster relationships with these firms. Understanding the investment criteria and strategies of PE can help in positioning portfolio companies as attractive add-on acquisitions, potentially easing the exit process.

For Tech Founders:

1. Capital Raising Strategy: Founders should be aware that the investment landscape is favoring larger, established players. Newer startups might find it challenging to raise funds. Founders need to focus on clearly demonstrating their unique value proposition and potential for scalability to attract investment amidst a crowded and cautious funding environment.
2. Building for Sustainability: In an environment where exits are less frequent and smaller in scale, founders should prioritize building sustainable businesses over relying on exit strategies. This includes focusing on revenue generation, cash flow management, and operational efficiencies from the outset.
3. Navigating Market Realities: Founders should stay informed about the broader economic and investment trends, adjusting their business models in response to these insights. For instance, in current conditions, prioritizing product-market fit and customer acquisition cost efficiency can be more crucial than rapid scaling often favored in more buoyant markets.

Both GPs and tech founders must stay agile and forward-thinking to navigate the evolving investment landscape effectively. This might involve refining investment theses, pivoting business strategies, or exploring new markets and technologies that align with long-term trends and market needs.

For more details:

Q3 2024 Pitchbook-NVCA Venture Monitor

Investment Trend Highlights:

Referencing the data up to August 2024, it's evident that Canada has positioned itself as a prominent player in AI investment globally. The number of Canadian AI venture deals highlights a significant growth trajectory, especially following strategic initiatives such as the Pan-Canadian Artificial Intelligence Strategy and the substantial $2.4 billion AI sector investment announced in the 2024 budget. This context underscores Canada's strong commitment to AI, as identified in Deloitte’s 2023 AI report, which ranks Canada third among G7 countries in per capita funding for generative AI companies.

In terms of VC capital raised, Canadian AI companies experienced significant growth, peaking in 2021 with over 500 deals and major transactions exceeding $100 million. However, as shown in the graphic, deal counts have sharply decreased since 2023, aligning with a global decline in AI investments. Despite this, Canadian AI companies raised an impressive $408 million in H1-2024, surpassing the 2021 peak of $310 million, highlighting that while deal count is down, capital concentration in fewer deals continues to support the AI ecosystem. (See Graphic Below for Comparison)

The global AI landscape has also reflected a similar trend, with significant deal size growth between 2020 and 2021. However, by 2024, both Canada and the global AI deal sizes have seen a decline, marking a slowdown in massive funding rounds. This might indicate a maturing market, where investors are becoming more selective in their capital deployment.

As seen in the graph, global AI deals reached their zenith in 2021, with deal sizes significantly outpacing those in Canada. Despite this, the Canadian market holds strong potential due to a robust AI ecosystem, supported by government initiatives and funding aimed at promoting research and commercialization. However, with declining deal sizes, the focus for both Canadian and global AI startups will likely shift toward sustainable growth, profitability, and generating tangible outcomes from AI innovations.

According to Deloitte, the number of AI patents filed by Canadian inventors increased by 57% in 2022–23 compared to the previous year. This growth rate outpaces the average increase of 23% seen in other G7 countries. The accompanying graphic highlights how Canada, while still behind the United States and Japan, has experienced significant growth in AI patent applications per million people. Canada's steady upward trend reflects its growing role in AI innovation within the G7, with patent activity serving as a key indicator of the country's leadership in the development of cutting-edge AI technologies. This positions Canada as a notable player in the global AI race, with sustained efforts in AI research and commercialization.

Key Insights:

• Canadian AI Deal Decline: Despite Canada’s leadership in AI innovation, there has been a sharp decline in Canadian AI venture deals since 2022, reflecting a possible cooling off in AI investment activity.
• Global AI Investment Pullback: Globally, AI venture deal activity has similarly seen a downturn after peaking in 2021. This suggests that the AI investment bubble may have reached its apex, and both Canadian and global markets are experiencing a recalibration in AI investment enthusiasm.
• Canada's AI Patent Growth: While deal flow has declined, Canada’s AI patent filings have surged, increasing by 57% in 2022-23. This sharp increase in patent filings suggests ongoing innovation momentum, which may lay the groundwork for future commercial opportunities.
• Strategic Focus on AI Infrastructure: The data on global and Canadian deal sizes, combined with insights from AI patent growth, point to continued investments in AI infrastructure and foundational technologies, despite the slowdown in venture deal volume. This suggests long-term optimism about the sector, even amid short-term market fluctuations, particularly with the government as it is leading the industry investment for AI in Canada.

For more details:

Mapping the Growth of AI in Canada Through Investment | CVCA Central

Startup & Entrepreneurship Highlights

Precision.ai is a Saskatchewan-based company that focuses on developing AI-driven technologies for sustainable farming. Their platform uses machine learning algorithms to analyze satellite imagery, weather data, and soil information to predict crop yields and optimize resource allocation.

For more details:

https://precision.ai/

Community & Events:

Upcoming:

Next on my agenda for the year is a investor focused event in Toronto and shortly after SaaSNorth the largest annual national B2B SaaS conference in Canada.

If you are an investor interested in SaaS North reach out directly to learn more about the Private Investor Session I will be be hosting. I look forward to connecting with the investor & startup?community in November.

Candid Capital Podcast Updates:

Live Stream Calendar:

• Live Stream Playback-Candid Capital Market Updates # LATAM
• Live Stream Playback- Candid Capital Market Updates #Vancouver
• Live Stream Playback-Candid Capital Market Updates #TELUS Ventures

October Episode Release: Building & Investing in Web3: Where Blockchain is Heading

Stay tuned you can learn more about Candid Capital on the LinkedIn Page Candid Capital