Even the most diehard venture capitalist would accept that 2023 was a challenging year for the industry. With the IPO and M&A markets largely closed for business, the lack of exits impacted returns. That in turn hit investor enthusiasm, resulting in lower allocations to venture capital funds. As a result, at $67 billion, annual US venture capital fundraising was the lowest since 20171. Meanwhile, deals were few and far between; in fact, according to Pitchbook, 38% of venture capital firms disappeared entirely from dealmaking in the first three quarters of 20232. So, what trends will influence venture capital going forward, and can the asset class perform more strongly in 2024?
A stabilizing macro environment
Looking forward, the Fed’s pivot towards progressively reducing interest rates, coupled with evidence that inflation has been brought under control, should help bolster investor confidence. Stable or declining interest rates will create a better environment for risk assets and should increase deal activity, and there is plenty of dry powder available, particularly to larger firms.
At the same time, there is no shortage of innovation providing the potential for growth. Most obviously, generative AI gave venture capital a much-needed boost in 2023 amid the generally sluggish environment; according to Crunchbase, more than a quarter of the money invested in US startups went to AI-related firms3. If the economic situation becomes more favorable, generative AI could become an even stronger market driver as the technology improves and new use cases are explored. Meanwhile, other potentially strong growth themes include data-driven manufacturing, hardtech, digital health, B2B and cross-border payments could help provoke renewed interest in venture capital.
A need for capital discipline
Mega funds have increasingly taken up available investor capital but are having a difficult time deploying that capital at the right pricing models and valuations. Those large funds raising in 2024 will tend to be smaller than their predecessors, with venture capital firms aiming to right-size capital to their investment strategies.
Pitchbook’s 2024 U.S. Venture Capital Outlook predicts venture capital invested into startups will be at a level similar to 20204. With the biggest funds dominating fundraising, limited IPOs and M&A activity and valuations still relatively high, small-to-medium sized funds face a challenging environment to raise funds and make deals.
Managing expectations
While there are some promising areas of opportunity, an economic slowdown is not a great environment for new, high-growth businesses. An uncertain environment has already seen the startup boom falter over the past two years, with the number of newly minted North American unicorns falling from 360 in 2021 to a mere 44 firms in 20235. This less exuberant atmosphere almost inevitably dampens investor enthusiasm for venture capital. Meanwhile, geopolitical tensions and political uncertainty in an election year may also impact enthusiasm for riskier investments.
So far, despite the challenging macro environment, founders have tended to continue to make valuation assumptions based on 2021 highs rather than current market realities. For venture capital dealmaking to regain momentum, startups looking to raise capital in 2024 are likely to have to be more realistic about their worth.
Time to recalibrate and reorganize
Overall, the market environment points to a reset rather than a rebound, with 2024 set to be a more stable but still demanding year for venture capital. As well as identifying opportunities and closing deals, GPs will therefore need to manage portfolios with expectations of longer life cycles until exit, while conserving cash to avoid the need to raise a new round where possible.
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1‘US venture capital fundraising hits a 6-year low’. Published by The Financial Times, 4 January 2024. https://www.ft.com/content/cfb186c8-22f4-4a82-b262-f4380a5d82b8
2‘38% of VCs disappeared from dealmaking in 2023’. Published by Pitchbook, 19 December 2023. https://pitchbook.com/news/articles/active-VC-investors-decline
3‘AI’s Share of US Startup Funding Doubled in 2023’. Published by Crunchbase, 29 August 2023. https://news.crunchbase.com/ai-robotics/us-startup-funding-doubled-openai-anthropic-2023/
4‘2024 US Venture Capital Outlook’. Published by Pitchbook, 18 December 2023. https://pitchbook.com/news/reports/2024-us-venture-capital-outlook
5‘Only 44 new unicorn startups were minted in North America this year compared to 195 in 2022. Here’s the complete list’. Published by Business Insider, 22 December 2023. https://www.businessinsider.com/new-unicorn-startups-created-this-year-2023-12
