Every time a new quarter begins, it’s an opportunity to observe the state of affairs by looking backward and forward with an eye toward the steps necessary to positively impact the future. Each year at the venture capital firm where I serve as General Partner and Chief Operating Officer, we research the state of startups in the Southeast, comparing identified trends in the Southeast to what’s happening in other major Innovation markets (typically, Silicon Valley, New York, and the Boston region). The data and insights go into a public research report that informs investment and fundraising decisions for our firm, portfolio of founders, investors, and partners for the remainder of the year and into the next.
As we took on the research and strategy exercise in 2023, four interconnected trends emerged. It has been well-documented that both the number of deals getting done and the amount of dollars deployed are down compared to 2022. But we were looking to discover what else is going on. And, more importantly, what should we do about it?
There’s no denying that the interest rate environment and inflation concerns have materially impacted the funding environment. Money is expensive, making funding decisions more difficult for founders and investors. But even as the market impacts have added some frictions to the funding environment, we see the seeds of lasting improvements in the Innovation Economy.
The hyped-up funding environment of 2021 and 2022 has dissipated. The 'growth at any cost' attitude and litany of Mega deals have all but disappeared. And that's a good thing. A heightened sense of responsibility and careful recalibration of venture capital funding have taken their place. Across the U.S. in Q3 2023, dollars deployed rose quarter-over-quarter, despite fewer deals happening. That pattern is mirrored in the Southeast, though the region has shown less aggressive swings and more stability than most other key innovation markets.
Zooming in on the investment behaviors in the region, there has been a shift to follow-on and later-stage deals, showing persistence on the part of investors. Concurrently, the average size of Seed investments has risen when compared to 2017 levels, a lasting impact of the maturation of the ecosystem over the past half-decade. The companies in the region that are capturing funding rounds (Seed and later-stage) lean heavily toward SaaS, Healthcare Tech, and Fintech – all proven, high-potential sectors.
Put simply, fewer deals are happening, but the ones completed are generally larger and going to more ‘proven’ startups and sectors.
High interest rates have led to a challenging funding environment, but at the same time, they've weeded out weaker startups. Investment firms are adopting a meritocratic approach, focusing on deal sizes that are more appropriate for the company being funded. They also are extending time windows between funding rounds to give startups time to scale, gain traction, and prove their impact. With larger Seed rounds and more follow-on and later-stage deals happening, high-quality startups are still getting funded.
Companies that are successfully navigating today’s market are benefitting from having the previous years ‘funding frenzy’ subside at the same time that more priority is put on tangible progress. Investors are keeping watch on tried-and-true business fundamentals like cash flow, burn rate, revenue growth, churn, and CAC. Founders are finding more ability to focus on solving real-world problems and on establishing the pillars of a sustainable business. The fundamentals-based approach to deploying capital has shifted funding to follow-on rounds and later-stage deals. In other words, the companies that are successfully raising capital are likely to be the ones that are showing measurable traction – and, by definition, those startups also tend to be more mature.
The challenging market, meritocratic investment mindset, and return-to-fundamentals business mentality appear to be motivations for VC investors. While it might seem counter-intuitive, challenging economic conditions do little to deter seasoned VC investors. Experienced investors, advisors, and money managers are still looking for unique opportunities that align with their long-term investment strategies.
The VC and startup landscape is undergoing a careful recalibration, marked by a heightened sense of responsibility and attention to measurable progress. This is not a market for ideas drafted on napkins (even good ones proposed by serial entrepreneurs). Today’s market rewards those taking calculated risks focused on providing solutions to known problems. And for those able to navigate today’s startup journey, the rewards can be tremendous – for investors, founders, and the Innovation Economy at large.
This article was originally published on Forbes Digital. Read it here.
