Where Does VC Go From Here?

Artificial Intelligence is the hottest thing going in tech right now, and the fundraising numbers back that up. Through the first half of the year, investors have dumped some $40B into AI startups, including the $11.3B that Microsoft invested across both OpenAI and Inflection AI.

With activity like that, you’d expect the overall market for venture investment to be on a roll.

Not so fast.

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In fact, even with that boost from all the AI enthusiasm, VC investment was down about a third in Q2 vs. the same period a year ago, with about 3,000 deals funded in the quarter. Even worse, the total amount invested — $39.8 billion,?according to Pitchbook ?— was down by nearly half, reflecting smaller rounds and reduced valuations. This isn’t just a U.S. problem, either. Venture capital funding was?down 48% worldwide ?in the first half of 2023 — down a shocking 86% in Latin America, 69% in Europe and 65% in the U.S. — around concerns with higher interest rates and slowing IPOs.

"I haven't written any checks in the past 18 months," Kevin Colleran, co-founder at early-stage firm Slow Ventures, told Reuters. "I have 30 portfolio companies that I need to help figure out how to survive. There is no point for me to add to the misery."

Brutal.

Early-stage companies, in particular, have been hit hard by this pullback, putting thousands of companies at risk right when they are at their most vulnerable. For investors, this makes sense. Why expose yourself to additional risk by playing in the seed stage when more sure things are available at later stages? But I expect to see waves of bankruptcies in the coming months as a result of this shift. (Both startups and funds.)

The good news (if any)? VC has needed a hard reset for years, and now might be the time for it.

Moira Schieke, founder and of Cubismi, a digital medicine company in Washington DC, described the situation concisely on LinkedIn the other day.

"The Venture model is broken. I think Venture today is a perverson of what it once was, it has been gamed and lost core discipline… when VC’s make millions off large deals, no matter who much they fail, something is clearly way off…. Establishing a leap forward in new value prop takes discipline and lean processes to spend as little as possible (as?Cubismi, Inc ?has done) then you get your perfected public marketing and take money and scale - these groups are investing not into solving real problems in order to generate new value, they are throwing money into?#hype ?buckets, which a huge problem esp in?#healthcare . They are wasting critical innovation dollars that are needed for crisis-level healthcare problems and this venture model puts all the wrong people in the drivers seat as decision-makers, who don’t fundamentally even understand the problems or have any real insight. Worse, they are putting patients in danger.?#healthcare ?professionals and?#physicians ?need to lead for responsible use of new tech, and we need systems to be problem-focused, not the broken “venture model.”

Where does this leave VC?

Return to value creation

The post-pandemic years have been a bonanza for VC investment and startup valuations. If it feels like things have been a little bit nuts, it’s because they have.

Case in point: More than 750 unicorns were minted over four quarters between 2020 and the start of 2022. That’s a pace of more than two per day.

Sustainable? Hell no. Fun to watch? I guess.

But the results were pretty predictable.

VC investors have increasingly been focusing on later stage deals not only because there were so many of them, but because they were offering better potential returns at lower risk than early stage. Why not bet on a winner when they were pulling away from the herd so quickly?

But, what looks like a sharp drop off from that pace is really just a return to more normal market conditions. That should mean that investors return to more balanced portfolios and stop chasing multi-billion dollar valuations that may never return.?

Embrace the full value of VC

Speaking of valuations, the current functioning of the venture market is already a departure from what came before.?

Unicorns = hype, most of the time, with investors chasing the next big thing and writing big checks to support it. But there’s a downside: Per Djordje Planincic, the founder of Plantech: “High valuations have literally been proven to ruin sustainable growth and place extreme pressure on both companies and investors. Real success isn't just about billion-dollar tags, but also profitability, societal impact, and job creation.”

Damn straight.?

It has not been a popular conversation to have in recent years (even less so now with the fight for LP dollars in full swing), but most VCs didn’t get into the business only to print money. Most of them are former operators and want to give back to the market and support big, ambitious founders doing important things. That mission angle has fallen by the wayside recently; time to bring it back.

What else? Is there more coming for VC than just a return to normalcy? Let me know what you think.

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