VCs and startups struggled to raise funds in 2023, but LPs and investors are ready to get back to backing early-stage companies.
Arielle Sheh, an investment manager at Germany-based PE and VC investing platform Moonfare, says 2024 will be a good year to invest in venture capital thanks to startup valuations stabilising and VCs selecting companies that can deliver efficient growth.
“2023 was overall a difficult year,” she says. “The macroeconomic environment made investing difficult and there was less dealmaking. For 2024, the outlook is more positive with more companies expected to fundraise this year and possibly more unicorns coming to the market.”
The numbers are already beginning to tell this story. While just seven startups crossed the $1bn valuation threshold last year, four have achieved this milestone just four months into 2024.
Investors seem to be taking the hint. According to Atomico’s 2023 State of European Tech report, 35% of LPs say they plan to increase their allocation to venture capital over the next year, more than any other asset class.
What other signs point to a return to venture capital investing?
1/ Startup valuations have fallen and are stabilising
Many startups saw their valuations slashed in 2023. Down rounds made up 21.3% of total startup fundraising in 2023, up from 14.4% in 2022.
Pavel Ermoline, an investment director at Moonfare, says later-stage companies saw their valuations drop first as the correction rippled its way through the market.
Almost everyone I speak to feels now is a great time to be investing because you’re seeing great companies with valuations that make sense and can be rooted in fundamentals.
“Starting from Q2 2023, valuations on the early stage then started coming back down,” he says. “We believe we have bottomed out in terms of valuations, specifically in the early-stage segment. This creates a timing opportunity to invest.”
According to Pitchbook, average valuations of early-stage startups were down 23% year-on-year in Q1 2023, compared to 77% for late-stage startups. Swedish buy now, pay later company Klarna is a case in point: it raised $800m in a 2022 funding round that valued it at $6.7bn, a massive drop from the $46bn valuation it boasted a year earlier.
“Almost everyone I speak to feels now is a great time to be investing because you’re seeing great companies with valuations that make sense and can be rooted in fundamentals,” says Ed Lascelles, a partner at AlbionVC. “I wouldn’t say they are cheap — there is still competition for good deals — but you are paying a fair price.”
2/ VC focus has shifted from hypergrowth to profitability
With funding harder to come by, VCs have urged startups to extend their runway; not only to stay alive but to prove they can find efficient paths towards profitability.
Companies are growing because of the quality of the products and the scale of the problem rather than brute force sales and marketing.
Investors are no longer interested in deals driven by FOMO (fear of missing out), or subsidising a startup as it tries to grow as much market share as possible by way of Google Ads. Instead, smart fund managers are seeking opportunities to invest in companies that demonstrate financial stability and a good understanding of what gives their company an edge on the market.
The best investment targets are “growing on average slightly less quickly, but typically more efficiently”, says Lascelles.
“The big focus on efficient growth has been passed on to the companies by the market,” he adds. “Those companies are growing because of the quality of the products and the scale of the problem rather than brute force sales and marketing.”
3/ It’s become easier to identify resilient funds and sectors
In 2021, venture funding in Europe exploded, with more than €100bn invested in the continent’s companies for the first time.
These record numbers and soaring valuations made it difficult to understand which investors were there for the ride, and which were making the most thoughtful selections.
“It was really difficult to form the right opinion on who is better than the others, because fundraising cycles were fast, deployment was fast and the market effect was just too strong,” says Ermoline. By comparison, he says today’s more challenging environment has created “a great moment to see who we should be partnering with for the next 10 years”.
Ermoline says that Moonfare typically prefers VC funds that have built a strong enough brand presence — likely through time on the market, a positive track record or a solid investment thesis — that they can continue to attract the best founders.
Sheh says firms that have been quick to identify thematic sectors where long-term growth isn’t linked to cyclical market trends are also interesting. She cites AI and climate tech as being two standout examples, where the technology will be necessary no matter the temporary economic headwinds. In 2023, climate tech accounted for 70% of total VC investments globally.
“When it comes to things like AI or climate-related companies, they are very prominent as themes but relatively young technologies,” she says. “So there is a lot of development at the early stages, and it’s this segment [where investors can] really capitalise.”
