My views on the VC market for 2023

I was thinking of writing my perspectives on 2023 earlier in January – but the month passed by so fast… It’s already mid-Feb! The good news is that my forecast for public markets was bearish back in December/Jan, and I would have projected markets to decline in Q1…. Now, how credible would I look with the CAC 40 recording its best month of January ever (+10%), along with NASDAQ up 16% or S&P500 up 9% ?....

Beyond public market indexes, let’s look at the fundamentals: after decades of low inflation, 2022 set record high inflation rates; the Ukrainian crisis and its impact on energy costs was a definite trigger, but at some point, the true cost of quantitative easing (namely printing money like never before) had to be paid. It’s economics 101 and there’s no free ride!

 Central banks have started raising interest rates to fight inflation through a prepared, necessary soft recession. The big question is whether interest rate hikes will carry on. So far, it looks like inflation is stabilizing, yet not decreasing. This is a first pivot. Interest rates will plateau when inflation rates start decreasing on account of a recession. Yet, the anticipated global recession is now being questioned, whereby we’d be more looking at a flat year. Meanwhile, unemployment is recording all-time lows, which does not help with inflation… As a result, public markets are back on their feet. The “clean” foreseeable scenario I had framed for 2023 is not happening – and hedge funds that had a similar reading are forced to buy back their shorts – which contributed to the January rally IMHO.

All in all, the 2022 bear market seems to have brought SP500, NASDAQ and EUROSTOXX 600 forward P/E in line with their historical averages – the big question is how public companies will perform and whether earnings will grow. There’s a 30% gap between TTM and forward P/E on the French CAC 40, indicating lower expected earnings vs. last year, and that alone questions current share prices….

 People will always argue whether markets are expensive or cheap; yet the beauty with public markets is access to information and liquidity: supply and demand balances somewhat nicely and forging one’s fact-based opinion is relatively easy.

 This leads me to the bigger question: where is Private Equity headed in 2023, specifically in Venture Capital where I operate?

 Free money led to over-feeding the VC industry with dry powder, relative to supply; GPs raised – and deployed - ever larger funds in ever shorter timeframes, leading to larger rounds and associated skyrocketing valuations. With said valuations going through the roof in public markets, you could find a rationale as NASDAQ multiples serve as a basis for tech PE valuation.

As much as public markets have adjusted rapidly – and sometimes painfully, PE markets are on the slow side when it comes to recognizing a loss. Late-stage VCs hold off as they’re unsure of book valuations and at what price they can IPO (or simply sell) their portfolio. Earlier stage VCs are worried that later stage investors won’t feed what they seed. With a broken financing chain, the market is stalled!

Startups that were told to grow at all cost and burn money that they could source easily are now asked to preserve their cash, if not turn EBIT positive as new funding is unlikely. This calls for major strategic shifts and associated reorgs. Some will survive it, others won’t.  

What I expect in 2023 on the VC front:

(1)  Seed stage funding will remain high and grow proportionate to other stages. There is available dry powder, and it will most likely be deployed at prices that will recoup the long-term trend. That’s essential to attract later stage backers and rebuild the financing chain. These companies will operate with heightened attention to unit economics and thereby build more sustainable businesses. We’ll see a lot more climate tech and health tech businesses launched to tackle more important issues than, say, dark stores do (people who know me know how I feel about those…)

(2)  VC-backed businesses, especially those that raised a lot at high prices during the 2019-2021 frenzy will need to rethink their model. Those with runway will adapt, will dive deep on their unit economics and hopefully be sustainable. Other will run out of cash and falter - or at best be acquired in a fire sale.  

(3)  The M&A market that took a shot in 2022 will be quite active as far as deals go but I don’t expect a lot of mega transactions. Among startups and scaleups, the strongest will absorb the weakest in a move to consolidate the market:  where too many operators were competing, margins were overly compressed, and VC money thrown at Google and Meta to win market share. Size does matter, and I expect to see a lot of paper deals in the form of mergers of equals, and smaller companies getting absorbed to acquire tech and talent.

Overall, I think VC deal count and value will be lower in 2023 vs. 2022. I also think that a new wave of seed funding will show up as entrepreneurs build smart businesses on the back of great (and useful) innovations. The market will resume and go back to normal, hopefully before the end of the year. It just takes longer in PE than public markets.

Now, public markets proved me completely wrong in the first 45 days of 2023 (remember, I started January in bear mode…) I can only hope the VC market does the same – I’ll happily swallow my pride as I care more about the health of our tech ecosystem, the jobs at stake, and the bright future that the entrepreneurs behind them are building for the generations that follow us.

And to prospective entrepreneurs: there’s no better time to start a business than in the middle of a crisis. You must be smart from day 1, and smart businesses tend to be sustainable!