2023 VC predictions: Finding an exit from the ‘messy middle’

To predict what 2023 will look like for venture capital, we need to start by understanding where we are now. We’re entering a messy middle where prices continue to drop and the “2021” deal, industry slang for an investment made at an exorbitant price, is long gone.

Companies can no longer raise $5 million to $10 million seed rounds with nothing but a deck and the assumption that revenue multiples will skyrocket beyond historical norms. The VC landscape has started to bifurcate, and it will continue to do so during 2023 both for fundraising and investments.

Fundraising: A tale of two worlds

In 2023, we will see two worlds emerge. The companies with the best talent, products and positioning will command capital at normalized market prices, and everyone else will experience a depressed market.

Due to the Fed’s rate hikes and geopolitical tensions, the macro environment has slowed and inflation hit record levels. Investor confidence is down across the board and growth rounds are largely dead on arrival, with both seed and Series A valuations down by 30%-50%. It’s now questionable to pump money into a company that doesn’t have the traction to back up its worth.

But this doesn’t mean all deals are off. Venture firms still have tens of billions of dollars to deploy, but they’re more hesitant about doing so now — growth, in particular, is experiencing a hanging-around-the-hoop effect that is likely to linger as the overall macro environment stays depressed.

At the same time, good companies in “safe” industries are still getting attention. To be clear, these rounds are happening at lower valuations than they would have a year ago, but as haircuts become more common, it’s still noteworthy.

This is true of exits as well — Adobe’s $20 billion acquisition of Figma has dominated headlines in a market otherwise characterized by slow M&A activity and no IPOs.

We expect this divergence to widen in the coming year. The key to success for venture capital firms will lie in their ability to select the managers and assets that have top talent, products and positioning.

Investing: Relationships win

Most LPs hit an all-time high in 2021 with their venture commitments. As the market pulled back and other asset classes dipped over the past six months, they began experiencing the classic Denominator Effect. Many endowments and foundations — long-time venture investors — now have venture allocations in excess of 30% of their entire capital base.

As a result, in 2023, we fully expect LPs to place less emphasis on venture as liquidity takes a premium and LPs rebalance their portfolios. Even though the best vintages originate during downturns, it’s difficult to allocate to something you’re already substantially overexposed to.

Of course, this translates directly into difficulty for emerging managers. It will get more difficult to close funds. Many LPs have already made rough allocation decisions for the next fiscal year and plan on a combination of re-upping with existing managers and cutting their worst performing. Few plan to add a meaningful number of new managers.

Emerging managers are best advised to focus their time on newer endowments and foundations still building their venture programs, as well as fund of funds and family offices. As a rule of thumb, if a group has been investing in venture capital for over a decade, they’re likely overexposed to venture as an asset class.

The story for mega-funds will be different, as we saw with Bessemer’s recent set of funds. Downturns tend to reinforce the platform and brand advantages, as LPs find safety in traditional names.

In the go-go 2021 market, relationships between managers and LPs were forged quickly. To properly plan for the economic weather ahead, managers should play the long game and lay the foundation for several years (and funds) to come.

To sum up, companies are still growing and so is venture investment. In 2023, regardless of whether you are fundraising or investing, you’ll be looking for stable moves and quality rather than aggressive deals and volume. It represents a pivot from the high-risk, high-reward short deals we saw in 2021 to more risk-averse, long-term deals.