For investors in startups it’s been a very interesting few years. Following the record breaking highs of 2021 and 2022, 2023 saw venture investors globally raise the lowest level of capital since 2015. (source).
While this has made conditions more challenging for startups, for investors looking to get started with investing in startups, there are several reasons why investing now makes sense.
Valuations have fallen
Startup valuations across all stages grew through 2021 and 2022, before starting to decline in Q4 2022. Through 2023, valuations at Series A and Series B stages continued to decline, while earlier-stage deals held firm, with some even seeing valuations increase (source).
While activity fell across all stages, later stage deals suffered the most, and investors began to move their money into earlier stage deals, particularly seed and pre-seed stage. These companies’ valuations were lower, and they weren’t carrying the ‘baggage’ of inflated valuations from the years before. In 2023, VCs invested just $39.5 billion in 5,421 early-stage deals, a significant decrease from the $70 billion invested in 5,519 deals in 2022 and the $87 billion invested in 5,997 in 2021 (source).
Nearly 20% of the funding rounds in 2023 were down rounds, as companies were forced to revise their estimates down to secure funding. Many companies doing their Series A and Series B rounds in 2023 had skipped the pre-seed stage entirely back in 2021, when higher levels of investment could be obtained more easily.
At this moment, as pre-seed valuations begin to fall once more in early 2024, it makes sense for investors to take advantage by investing in early stage companies before their valuations begin to rise again.
Better terms, better startups, more for less
Investing at pre-seed stage in 2024, as well as giving investors the ability to get in at a lower share price, makes it more likely that you’ll be able to find investment opportunities that are more favourable to investors, with startups who are more willing to negotiate. Because the investment environment is tougher for startups, and money harder to come by, investors have a lot more leverage for the money they can offer.
As an example, law firm Fenwick and West found that the number of Silicon Valley venture financings containing ‘pay-to-play’ provisions — that forced previous investors to participate in funding rounds or risk having their ownership diluted — hit a record high of 7% in Q2 2023, rising from 1% in Q1 2021, before falling to 4% in Q4 2023 (source).
An added benefit to investing at this point in the downcycle is that the companies seeking investment who have managed to weather a less cash-rich environment have already gone some way to prove their viability, while those who couldn’t make it work have folded. Companies looking to raise pre-seed rounds in 2024 are doing so in part to develop a Minimum Viable Product (MVP) and demonstrate that there is demand for their product, reducing the burden of high valuation expectations before product-market fit has been established.
One interesting new element is the role of technology – specifically generative AI tools – in enabling businesses to establish themselves faster and for less, whether it’s through automation of code or content. This means that for investors, putting money behind a company at its very earliest stages can be done more cost effectively than previously, but also that there is stiffer competition between startups to get things done efficiently.
As interest rates fall again, traditional investments become less profitable by comparison with venture capital.
Inflation skyrocketed between 2021 and 2024, rising from 0.3% in November 2020 to 11.1% in October 2021, before interest rate hikes saw it fall again to 2% in July 2024. The Bank of England cut interest rates for the first time in four years in August 2024, from 5.25 to 5%, and while rates are still high, they’re expected to fall to around 4% by the end of the year.
As interest rates are brought down, the significant returns from traditional investments like bonds start to fall too, and investors begin to look to higher risk opportunities to increase their returns. Investing in venture capital now, as rates are starting to fall, means that the early-stage companies you invest in today will be looking to raise their Series A and B rounds in a year or so, when rates have fallen even further, and more and more money coming into the market has driven valuations up.
SyndicateRoom has just launched its latest SEIS fund, in partnership with Founders Factory, which focuses on investments in pre-seed, B2B SaaS businesses to capitalise on the new opportunities made possible through the implementation of AI technology in early stage businesses. You can find out more about this fund, the SEIS tax reliefs available to investors and make an investment using the link below.
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