Veni, Vidi, VCs back to first principles

The VC industry is returning to first principles as the funding winter drags on into early spring. Higher interest rates, lower valuations and stock market volatility have made returning or raising capital more difficult, and conditions are expected to remain so in the near future. This has contributed to a more prudent approach by PE firms that have sharpened their focus on smaller startups in sectors with greater visibility on profits and better governance. This is a reaction to global excesses at the beginning of the decade when size had become the main yardstick of performance, overriding the specificities of business opportunity, unit economics and board oversight. As money-chasing late-stage startups that were poised for listing dried up, the VC industry has acquired greater responsibility for the ventures it is nurturing.

Not all lessons may have been properly internalised, though, given the insatiable investor appetite for AI, which is threatening to spill over into the PE market. As of now, the broader markets provide enough opportunity for investors to bet on AI, but as the new technology rapidly spreads into the nooks and crannies of various industries, the VC industry could be sitting down to feast after a famine. Some of the newfound prudence could abate as extraordinary returns make a comeback. The lessons from the funding winter should, however, not be lost entirely, a point made at last week’s ET Now GBS by more than one guest speaker.

Startups will emerge from the drought with stronger balance sheets, and valuations will be in closer alignment to revenues. Both entrepreneurs and investors have acquired a degree of sobriety that would have been hard to come by even a few years ago. Regulations to blow away excess froth are also in place. These may be building blocks for tighter rules when the next big wave of risk capital arrives. It may be sooner than anticipated. But, this time, we are better prepared.