2021 was an outlier. 2022 was carried by momentum. 2023 may be the fine-tuning of a new market structure.
There is no getting away from 2022 being a challenging year for Venture Capital. The lingering impacts of the COVID-19 pandemic, rising interest rates, and conflicts abroad have impacted the VC industry and upended the assumptions on which the modern economy was built. As a result, the pace of venture investment and late-stage tech valuations have been declining throughout most of 2022. However, early-stage investment activity is robust with VC funds shifting focus to earlier stage companies while waiting for public market turbulence to abate. Other positives are that VC funds were backed to the tune of $238.3 billion, with US-based funds raising a record $162.6 billion. This level of dry powder has to offer massive encouragement to start-up companies. The big question is where this huge amount of investment capital is likely to be deployed in 2023?
We take a look at the factors most likely to shape investor demands and where some of the best opportunities might arise in terms of investment stage and also types of businesses.
- A resilient new generation of founders will emerge – in the past a tough economic back drop has produced founders that are more robust, more strategic, more determined and far more resilient as they compete to attract investment.
- Founders just starting out will be one of the best investment opportunities – in 2022, early-stage VC attracted $68.4 billion in the US, well ahead of 2020 and only slightly down on 2021. Tougher times also mean better pitches from founders and better run companies with business plans focused on sustainable growth. Companies that can build market share during challenging economic conditions, are best positioned for accelerated growth and high value exits once the ‘good-times’ return.
- Disruption leads to opportunity – less funding forces companies to be more creative and to focus on solving problems that people are willing to pay for. As economic conditions fluctuate, we are likely to see this new breed of entrepreneur creating products and services that solve some of the world’s biggest challenges.
- Investors will favour profitability (or at least a reasonable path to get there) over the promise of future growth – Public markets have quickly shifted away from placing a high premium on revenue growth as the leading performance metric, highlighting how VC-backed companies must shift their strategies to building solid business foundations.
- Robots will boost productivity and plug labour shortages – as the global workforce shrinks and the population ages, the adoption of robots and automation will be key to boosting productivity. Business will find it’s the only way to deliver the output they need with the workforce available.
- Supply chain issues will get worse before they get better – China’s lifting of their Zero-COVID policy will cause major output challenges in manufacturing in early 2023 before returning to levels of output not seen since 2019. The initial log jam will push companies to source local solutions and introduce new efficiencies through technology.
- With more funds now managed by women and people of different ethnic backgrounds, new investment criteria and knowledge will lead to the backing of more diverse investments – data shows female led companies out-perform the broader market by exiting faster at higher values for investors. More investors will double down on diversity as the smart play in 2023.
- Equity crowdfunding will continue to grow and change the market – with rising interest rates and complex loan approval processes, entrepreneurs are skipping bank loans and heading straight to venture capital financing opportunities. The venture capital crowdfunding market in the US is predicted to reach nearly $43 billion by 2028. Equity crowdfunding alone is expected to grow to $25.8 billion by 2026. The promise of follow-up funding is often a win-win for both the start-ups and investors. They provide the companies with the funds needed to continue growing the business whilst allowing investors to increase their holdings in the companies they like.
- Venture Capital will continue to shift to International Markets – VC investments in European start-ups now account for 18% of the total global VC funding. More and more US based investors will look to expand their investment portfolios seeking value in European growth opportunities and then opening the door to possible global expansion including the US.
- The Post-digital Era begins with several emerging technologies poised to experience rapid growth as they transform society – The exponential growth of the past decade that drove mass adoption of digital goods and services has laid the groundwork and foundations for a new era of technology innovation. Today’s global consumer is tech-savvy with a powerful technology infrastructure at their disposal. The post-digital era will also benefit from a larger, more robust funding ecosystem. This is clearly demonstrated in the raw numbers showing 2022 was a great year for the VC industry, with most indicators of market activity at or near record highs. When graded against any year other than the stratospheric 2021, industry activity was extremely strong. Emerging technologies predicted to thrive in the post digital era include:
- Electric Vehicles – currently less than 5% of cars on the road. As this increases to 50% it will lead to exponential growth for OEMs, data management services and developers of charging grid infrastructure.
- Climatech – could prove to be a relative safe haven driven by the US’ Inflation Reduction Act, offering $370 billion in support for climate technologies. Look out for the increased emergence of carbon removal technologies, renewable energy and residential energy efficiencies through high-efficiency HVAC, residential heat pumps and solar panels.
- Healthcare – value-based care initiatives, digital and home-care services, mRNA biotechnology and remote therapeutics.
- Cultivated Proteins – VC funding more than quadrupled in 2022. Set to surge further if the FDA approves UPSIDE Foods permitting them to sell in the US and beyond.
- Generative AI – Agentic models incorporating imitation learning are set to make the next major step in Artificial Intelligence. AI investment has increased from $12.75m in 2015 to $93.5 billion in 2021 and projected to reach $422 billion by 2028.
- Gene Editing – Gene therapy and gene editing are on the cutting edge of modern biotechnology enabling scientists to change an organism’s DNA. The market is forecast to grow 53.1% annually and reach $59.5 Billion by 2027.
Many large VC investors are expressing guarded optimism for the year ahead. In the past, disruption and economic downturns have led to increased innovation in the VC market. 2023 is forecast to bring more resilience amongst companies, more rigorous due diligence by investors seeking sustainable growth plans, more diversity and a greater focus on solving the big problems that matter.
CSS portfolio companies, many with disruptive digital technologies, are looking to put themselves firmly in the shop window seeking to attract growth hungry suitors. To find out more click HERE.
Since 2001, CSS Partners has raised over £175m for ambitious growth companies. Over this time we feel we have developed a good understanding of what investors want.
CSSP backed companies will often offer EIS Shares so investors can use the significant tax breaks of the UK Enterprise Investment Scheme to help mitigate the risk of venture capital and maximise returns.
Investments offered by CSS Partners are not appropriate to all investors. Our free client service aims to be of benefit to high net worth and sophisticated investors looking to achieve higher returns.
19 January 2023
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Any views or opinions expressed in this blog are those of the author alone, except where specifically stated that they are the views of CSS Partners LLP.
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