Venture Capital in 2023 — Emerging Trends and Issues

How FOMO, Diversity and Risk will shape venture capital and startup fundraising in the next year.

More than 91,000 tech workers have been laid off so far in 2022. A lot of them are from the likes of Meta, Twitter, Amazon, Lyft, Stripe and other tech giants.

Many are well-paid, highly talented software engineers or senior business executives. They will probably be reluctant to take a job with lower pay or join a young startup with founders less experienced than them. That, and the expectation of a global recession for the next 1–2 years, will make re-entry into the job market difficult for those who were laid off.

More likely than not, in 2023 a large number of them will try their hands at being founders. This will likely result in a lot of new startups for VCs in the early-stage game to choose from.

But despite what could be a bumper crop of new companies for VCs, their selection process will be influenced by three trends which can be summarized by the following three words: FOMO, Diversity and Risk.

Hurt by FOMO

2022 saw the bubble bursting on a lot of faddish startups — Crypto, DeFi, Fintech, e-commerce and the likes.

Many attracted millions and even billions in capital despite not having sustainable business models and questionable governance. Some were funded richly even when they were just an idea on paper (think Adam Neumann’s comeback gig and all the ICOs of the 2017/18 era).

2023 will be the year that VCs really start to pay for all their FOMO plays in their balance sheet. Already billions have been written off for spectacular implosions like Terra Luna, Celsius and FTX. More startups peddling dubious solutions or technologies will emerge out of the woodwork — especially among crypto and blockchain plays.

Going forward VCs will probably try to self correct and over compensate by scrutinizing portfolio companies harder and getting more involved operationally.

2023 will not be a comfortable year for founders who were funded by VCs taking hits from their past FOMO plays. For those hoping to get funded, the trend/hype building cycle will reset and a ‘hot new theme’ will take some time to emerge again. Easy money will not flow like the way it did for the last few years in crypto plays.

Diversity rules!

Many VCs have admitted in private that most of their deals came from startups ran by founders from within their network. In fact, Harvard has done a study that concluded as much.

But in this era of woke and allies, being part of the old boys club may no longer put you first in the running.

In fact, being a female founder, hailing from a minority race, or starting a business in Africa may put you ahead of the race to pitch and get funded.

VC’s these days, much like big companies, are increasingly reporting their portfolio’s diversity figures proudly. And since startups that actually have such founders are still in the minority, the odds work in their favor.

From 2023 onwards this will become increasingly plain. There are already funds and angel networks purely focused on female or minority led startups. More will emerge as funds start to sell this as a thesis and theme to their LPs.

Venture capital is broken

Peter Thiel’s Founders Fund believes that venture capital is broken. It has shifted away “from backing transformational technologies” to “become a funder of features, widgets, irrelevances”.

“We believe that the shift away from backing transformational technologies and toward more cynical, incrementalist investments broke venture capital.” What Happened to the Future?, Founders Fund

He’s right. Anyone who has spent enough time in the startup ecosystem today will tell you that many VCs are actually risk averse. They try to ‘de-risk’ their investments by investing in startups that have revenue traction and partake in deals that other VCs seem to think are good bets too.

The success of Y Combinator and other startup accelerators established globally accepted methods for validating startup ideas. These can be easily learned from the numerous books, YouTube videos and Medium articles out there on the subject.

Similarly, plenty of free online resources and accelerator programs teach the exact same approaches to crafting the perfect pitch deck. In fact, the slides that go into the deck has become so standardized I’m surprised nobody has created an A.I. filtering software yet to do the initial screening instead of human scouts and junior analysts.

But ironically even as these established methodologies and frameworks take hold, half of the ballooning number of VC funds produced “flat to negative return for the past decade”, and “only a handful” of funds have done very well for the last 20 years.

So what happened?

Aren’t methodologies gleaned from decades of learning and institutionalized approaches suppose to produce better results?

Putting risk back into venture capital

The answer goes back to the very definition of venture capital itself.

The Chinese words for venture capital (风险投资）literally translates to “investing in risks”. Venture capitalism was invented for this very purpose. But now it gravitates towards surer bets that can be quantified using conventional metrics gleaned from the past and playing ‘pass the hot potato on’ in FOMO theme plays.

As the Founders Fund manifesto puts it, venture capital is meant to uncover and invest in transformational technologies that can shape the future. Since risks and returns are directly correlated, the successful bets on highly risky plays also produced enormous returns.

The only way to source and assess startups that truly have the potential for this is to engage specialists and domain experts. They would have the knowledge and industry network needed to evaluate transformational technologies and potential market sizes.

Most founders with no partner connections would have their first meeting with a deal broker, VC scout or junior analyst from the firm. One could imagine the number of transformational technologies that were turned away because they had no clear revenue model or user traction yet.

In other words, many VCs today are on the wrong side of ‘the crowded restaurant theory’. They need to be getting into the kitchens and tasting the food — instead of standing outside the door and counting the crowd.

2023 will be an important year of reckoning and reset for venture capital. Let’s hope they get back to funding the true visionaries, instead of charming and opportunistic founders putting up lemonade stands because the weather is hot right now.