Venture Capital Is Going To Heat Back Up (2024)

Everyone knows how AmazonAMZN started as a simple book store or how Meta began in a dorm room. At some point all of today’s great companies were just a passion project, a great idea in need of capital, employees, and the first real customer. While some ideas grow to become companies organically without outside investors, most companies need help. They need capital, they need expertise, they need connections and support.

Venture capital investing is the process by which these great ideas get funded and become dynamic companies capable of scaling and growing profitable. The return profiles for successful companies can be huge, but it’s an incredibly nuanced and risky part of the investing world and not suitable for everyone. Nonetheless, it’s where the best ideas are tried, tested, and eventually brought to fruition.

Investing in Venture Markets

You can’t invest in the venture space without recognizing that failure is an essential part of the creative process. Venture companies are dreaming big – and not every moonshot works out. In fact, most small companies end up failing and shutting the doors. Investing in the space successfully hinges on one or two ventures succeeding within a much broader portfolio. The companies that make it often hit escape velocity - they can hyperscale and the the returns can be exponential. The returns on a single venture investment could be enough to justify dozens of failures.

The complexity of the market is further complicated by the lack of transparency and minimal reporting requirements. The environment is rife with fraud and exaggeration. A great idea may be nothing more than an idea and may have no substance or practical marketability. Successfully navigating the venture space consequently requires a nuanced understanding of how businesses are run and an astute approach to avoid falling prey to exploitation. Subject matter expertise is also essential to see through the sales pitch and understand the substance of the idea.

Finally, we have to take a moment to discuss how hyperscale growth can be risky even when it succeeds. Unlike mature companies who are kicking off cash to investors, most venture investments are purely growth oriented. That growth can be awesome, but can also lead to long investing time frames – venture investing is not for those who need liquidity, even if they can handle the risk.

However, for those with the risk appetite, the time, and the expertise, the venture space can be incredibly rewarding. Diversified and done properly, a venture capital fund can be a vehicle for cutting edge ideas to become wonderful portfolio investments experiencing exponential growth over time.

Timing The Economic Cycle

This already exciting space is even more intriguing because of where we are in the market cycle. Smaller companies are typically the most exposed to the broader economic cycles and the venture space is no exception. The past two years are a great example. Inflation and interest rate hikes put a damper on the economy and small companies took it on the chin. Exuberance in 2021 turned into austerity in 2022; it’s hard to overstate the monumental shift in perspective. Think about some public market companies with established user bases and real products – companies like Teladoc or Zoom or PayPal. In 2021 their valuations were extended, and in 2022 and 2023 those valuations came tumbling downwards.

The same thing happened in private markets and in venture capital markets. In many cases it was actually worse in venture markets as the underlying products were far less tried and tested. The stress on the venture space was further exacerbated as soaring interest rates and a crisis of confidence caused the collapse of the venture-oriented bank SVB. Consequently, raising funds in venture markets today has become much more difficult. Many ventures have shut their doors and those still standing are fighting to raise capital at any valuation. Rather than looking for growth and appreciation, founders are looking at flat fundraising rounds as a victory.

This is also reflected in the IPO market. Many successful venture companies have delayed their public market debuts and have opted to stay private until capital markets start to open back up. The lack of activity in the last year or two stands in stark contrast to the successful listings of companies like Snowflake or Doordash when markets were less troubled.

However, companies resilient enough to weather downturns tend to flourish when market conditions improve. Difficult market conditions make it essential to not only have a good idea, but to become a good operator. Conserving cash, focusing on profitability, finding ways to efficiently acquire customers – these are lessons that companies learn during downturns. Taking that expertise to the broader market when capital markets start to unlock can lead to rapid growth both in terms of profitability, and in terms of the valuation of the firm.

AI Drives Venture Opportunities Today

We believe a stressed venture market represents a great investment opportunity. A stabilizing economic environment, attractive valuation rounds, proved out concepts, and a burgeoning wave of innovation is an exciting combination.

While we believe there are opportunities across sectors, we think the opportunities in technology are attractive. AI in particular stands out to us as a driving force for change.

AI is not only revolutionizing industry giants but also unlocking immense opportunities for small companies. Its role as a catalyst for innovation and creation is particularly pronounced for small businesses where resources are constrained but creativity is not. Many large companies are encumbered and unable to take advantage of AI. They have decades of old code layered on top of each other, systems that don’t integrate, management that’s afraid of change, and compliance that’s afraid of making a mistake. The bureaucracy of the large company doesn’t lend itself well to innovation and change.

Small companies on the other hand are looking for any edge they can find. AI empowers small teams to navigate more efficiently through the development of intricate code and products within compressed time frames, streamlining the journey from ideation to implementation. Small companies without any existing infrastructure are also more likely to use AI that might still be a work in progress. Take for example using AI to assist in customer interactions. A company with an established customer support team is going to look for ways to augment their team, and the team isn’t going to push any AI angle that would imperil their jobs. On the other hand, a small company without any customer support at all is going to look for every possible way to utilize an AI agent to minimize their hiring needs. An imperfect AI that they can improve over time is more valuable than having no support at all.

The Focus On Operational Execution

The way AI allows small dynamic teams to punch above their weight is creating a new playing field for small companies and venture investors. Code creation is getting easier as AI tools continue to get upgraded and AI is also a wonderful assistant in the world of design and marketing. Said another way, AI is shortening the ideation and creation phases of the innovation cycle. Ideas can be built, tweaked, tested, and put on a scalable platform faster than ever before.

This significantly increases the importance of operational execution in the venture environment. If everyone’s code is going to work and everyone can create marketing material, then it’s the way you manage the company that will differentiate winners and losers. Investors increasingly need to weigh the quality of the idea against the quality of the management team. Finding companies with both great ideas and the capacity to find the right hires, get patents filed, find contracts, and successfully manage cash flows will become paramount.

This in turn means the skill set of successful venture investors is likely to change. The sector specialist will always be important - fast moving technology necessitates it - but operational expertise is going to become increasingly important. Venture investors will need more founders and operators sitting on investment committees and providing operational advice and support to their portfolio companies.

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