Winter: How the Venture Capital Market Reacts to the World’s Events & What Startups Should Pay Attention to

Hey there! My overview of the current market situation and the forecast for 2023 was originally published in Poland (Brief). Here's English version for global readers.

Despite the events taking place, our venture capital fund continues to invest in projects.

But I won’t be talking about the studio in this piece. Instead, I would love to share with the community my thoughts on the current situation — perhaps someone will find them useful. 
I will start by saying that the current situation is nothing new for the market. The reaction of venture capital players is the same as in any crisis time.

On the one hand, there is a traditionally obvious recession. Large companies are reducing their staff and preparing for a ‘long winter’. There are a lot of negative factors and forecasts pushing us to lose heart and tighten our belts.

On the other hand, the market and investors still have plenty of money. Both before and during the pandemic, governments actively printed money to solve the economic problems, and a lot of new funds emerged — usually with an average seeding time of 3–5 years. They already have billions of dollars to seed within 5 years.

At the same time, most of the startups that received investments before winter 2022 launched at a good time (even with COVID and its consequences for the global economy). They mostly aimed at valuation and rapid growth instead of short-term profits.

Hence, the funds that are OK on money still have to invest. But instead of investing in the glorious future, they will be pouring money into the ‘here and now’ companies.

Are you saying that the situation is not very different from what it was during the pandemic?

No, it is different! Because it’s gotten worse. I would say that during the COVID-19 outbreak, VCs were also looking more for those able to make money — just on a smaller scale.

  • Before COVID, a founder would say, “For the next 5 years, we are a startup. We’ll be working without revenue” and an investor would say, “Okay, let’s go.” 
  • During the pandemic, the conversation was the same, but the period of operation without revenue shortened from 5 to 2–2.5 years.
  • Now, the threshold of revenue expectation has fallen to roughly 6 months.

Here’s the next important difference: as a physical location, Silicon Valley is gradually ceasing to be a Mecca for startups in search of investment.

Sure, there is still more investor money in the U.S. than anywhere else. But in terms of remote cooperation with investors, the effects of the pandemic seem to stay with us for good. Previously, founders had to visit the Valley to raise a round, but now U.S. players are ready to invest in startups that have no physical presence in the Valley. This trend has spread throughout the entire country. Objectively, America continues to be the biggest investor, but now it’s not so pronounced. Besides, both Europe and Asia started moving strongly in that direction — and this time, startups may as well get on this IT hype train.

In addition, there used to be a trend towards globalization (more on that below), whereas now the agenda includes questions like “What country are you from?”, “What market do you work for?” and so on.

It seems to me that investors, especially European ones, have begun to understand that local solutions are not just a matter of prestige — it’s a matter of security. If something terrible happens and everyone has to isolate themselves within their regions (Europe, Asia, USA), then being isolated with bad technology is not a great idea.

This is the difference between the current crisis and the pandemic, and it must be taken into account.

What is in demand now? Are there ‘default routes’ for startups?

Let’s start with routes. A year ago, promising startups had to choose between these two standard schemes of development:

  • Starting in the local market, testing the idea and then going global.
  • Launching immediately on the global market, testing hypotheses and developing there.

Now, in part because of political risks, a new trend is gaining speed — a movement away from globalization towards localization and field-level originality. Previously, we took it for granted that with investments, a startup could expand on a global scale. But now this factor is no longer obvious. In the current reality, going global may attract unnecessary risks, so companies will think twice whether it’s worth it.

As for demand, this question is broader.

The IT startup industry is pretty worn out. It has tested all sorts of models and tried every single thing under the sun, so now there’s no point in expecting such big breakthroughs as before. 
So there is a clear shift to engineering, construction, and other industries that can be digitized. Indeed, this has happened before, but it was more often experimental — the mainstream was still in SaaS, FinTech, MarTech, and so on. Whereas now, everything moves towards improving the ‘good old’ industries from software to hardware.

So do funds give money to startups or not?

They do, but the vector has changed.

There were reports in the media from various funds that they cut 10–20% of their staff and stopped hiring new people. It makes sense: an experienced venture capitalist knows how to be lean. Going into economy mode is the new black. But these are internal company changes. What about external ones?

They used to look more at visionaries and their prospects for the next 10 years. But now they look at those who can sell their products, build successful marketing channels, and so on and so forth. In short, they prefer the ‘centaur’ business model.

The term ‘centaur’ was coined by Bessemer Venture Partners to denote startups with an annual recurring revenue (ARR) of more than $100 million. BVP estimates that there are a total of 150 centaurs worldwide, 60 of which fell into this category in 2021.
By comparison, there were 1,058 unicorns last year according to the Hurun Global Unicorn List — almost ×2 of the number of companies with more than $1 billion in capitalization in 2020. By the way, in terms of the number of unicorns, 2021 was the most successful year in the history of the venture capital industry.

Now, let’s imagine something like a ‘venture barometer’. It has two markers:

  • on the left — ‘All is well’ (i.e. “We are ready to invest in new risky projects”),
  • on the right — ‘We are in crisis’ (i.e. “We are still ready to invest, but only in centaurs instead of unicorns”).

Between these two markers, there is a scale that shows the risk level and a moving arrow pointing at it. The arrow is now steadily going to the right, so everyone is cutting costs and looking mainly for companies that make real money and not just sell promises of a better future. There is nothing good or bad about this; it’s just a given in times of crisis.

It means that in order to raise new rounds, existing unicorns urgently need to turn into centaurs. As for new projects, they should focus on getting stable profits immediately, and not ‘after the third round’.

Nevertheless, let me remind you: there’s still a lot of money in the industry. It’s just that the rules of the game have changed. Very soon, we will see if the ‘summer children’ can prepare in due time for the ‘long winter’ of venture capital.

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