Global tech investment is facing a squeeze. Research from PitchBook shows a marked 48% drop in global VC funding which could signal a slowdown of investment across the tech space. Investors point to high-interest rates, which have suppressed company valuations and curtailed the number of imminent IPOs.
Kyle Stanford, Pitchbook's lead VC analyst, emphatically stated: “At a very broad level, funding for this year is pretty much shot.”
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Not surprisingly, the exception is generative AI, which is clearly bucking the investment trend with massive stakes being made, including $1.3 billion to Inflection AI - a start-up supported by Nvidia and Microsoft. The Seattle-based tech giant has also made a $10 billion investment in OpenAI. Total investment in AI is reported to be more than $40 billion in the last six months alone.
Earlier in the year, the collapse of the Silicon Valley Bank, which had a reported 20,000 start-up account holders, signalled that investment in the tech sector was not the safe bet it once was. Investments are still being made but slower, with investor caution being the main driver.
What is causing the slowdown in VC funding?
Gareth Jefferies, Partner at early-stage tech VC, RTP Global, explained to ITPro the current factors impacting VC investments.
“The simplest explanation is that when interest rates rose and the public tech markets downturned last year, a large proportion of the institutional limited partner (LP) market was quickly overexposed to alternatives, for example, PE and VC. So, their willingness and ability to continue investing in VC funds is lower than it has been and will continue that way for a while.”
ITPro asked Philippa Sturt, a corporate law partner at Oury Clark, to outline the key factors contributing to the current VC investment slowdown.
- Investor attitude: Sentiment within the investment community plays a crucial role in VC investment trends. Suppose there is an overall negative sentiment or a general sense of pessimism among investors due to factors such as market conditions or economic indicators. In that case, it can contribute to a decline in VC investment activity. The current macroeconomic climate (inflation, employment levels, international trade, and national income) has contributed to a negative sentiment among investors as it has led to a steady increase in the cost of capital, making VCs more reserved about the investments they are willing to make.
- Misalignment of interests: This is a common problem for VC investment. VC firms are typically motivated by financial returns, while entrepreneurs often focus on building their companies and achieving their mission. This can lead to conflicts of interest and challenges in aligning the goals of the VC firm and the portfolio company.
- Limited deal flow: One of the main challenges VC firms faces is finding high-quality investment opportunities. With so many startups seeking funding, it can be difficult for VC firms to identify the most promising companies and secure deals.
- Limited exit options: Exit options are limited in VC, as most portfolio companies have yet to be ready for an initial public offering (IPO) or acquisition. This can make it difficult for VC firms to realize returns on their investments and can lead to longer investment horizons.
- Limited transparency: VC firms often have limited transparency regarding their investment strategies and portfolio performance. This can make it difficult for investors to assess their investments' risk and potential return, leading to mistrust and a lack of confidence in the industry.
The multiple factors that are impacting investor decisions show no sign of resolving themselves. Interest rate rises may be slowing but are still taking place as governments attempt to slow the rampant impact high-interest rates can have on investment levels.
Strategies for surviving a VC funding drought
The continued VC investments in AI notwithstanding, how are tech companies managing what is – at the moment, at least – shrinking financial resources, at a time of rising interest rates?
Demonstrate the value of investing into GRC technology to decision-makers.
According to Bogdan Gogulan, CEO and Managing Partner at NewSpace Capital, there are two ways businesses can still succeed in such a climate.
"The first one is strategy. If the strategy is right, you can be wrong on tactics and still win, even in a challenging environment. It is essential to focus on a real market – a large existent market – with a fundamental challenge and tackle it profitably. Trying to create new markets in the current environment is more difficult. We see this clearly across our portfolio: being in SAR or laser communication, and solving pressing problems in a multibillion-dollar market, puts the company on a stable trajectory.
“The second key thing is liquidity," adds Gogulan. "A business plan should be fully funded. Raising money every 12 to 18 months, given current fundraising timelines, is impossible and very distracting to the business. So, teams should be prepared to raise more money at a lower valuation. It will pay off when they win in the marketplace against those teams who did not do it.”
The investment slowing may be just that – a slowing based on the current economic climate. Businesses that can weather the storm should see investment levels recover if the global economy also bounces back, with interest rates, in particular, falling to what investors would consider the status quo, unlocking confidence once again.
The path to recovery with investment levels is still being determined. However, as RTP Global’s Gareth Jefferies comments to ITPro, the outlook needs a common sense approach.
“VC still exists to fund businesses to scale through extended loss-making periods. We continue to ask the same questions we have always asked ourselves: 'How big can this get.' 'What will it take to get there,' and 'what's the opportunity cost of capital with this investment?'
“If you’re confident that the capital market will reward you for growth, even at the expense of self-sufficiency, then now is a great time to be aggressive," he adds. "But you have to take a dispassionate and objective view on your own business and the fundamentals of it.
"If you are not in a market that can sustain a VC-scale outcome, or if your business fundamentals are not more conducive to those kinds of outcomes than others, then now is the time (while you have the runway) to trade off some of that growth for profitability or self-sufficiency.”
And which industry or sector the business is in can have a great impact on how investors see these enterprises.
NewSpace Capital’s Bogdan Gogulan concluded: “At the moment, it appears that LPs are relocating their funds to blue-chip VC firms and focusing their strategies on industries, like AI and space. The mid-size generalist investors are likely to suffer from this trend, but the market will win in the longer term. As financial resources are allocated more intelligently by the specialized investors that follow a "buy-and-build" rather than "spray-and-pray" approach, stronger and more sustainable companies will emerge, reigniting economic growth.”
The light at the end of the investment tunnel is on, but it's perhaps less bright than it once was. Aside from AI, which is clearly seen by many investors as being a safe bet, global investments are down, and the future remains uncertain for other sectors as investment switches to safer opportunities. History, though, illustrates that investment can be cyclical. How long businesses will have to wait before the investor purse strings are loosened needs to be clarified.
