Investors are nervous.
They are nervous because they fear they overpaid for many private companies in the past few years, and it will be years before they see an exit. They are nervous because they don’t know how the interest rate rises and high inflation will reshape the capital markets. They are nervous because globalization has cracked, and a de facto tech and trade cold war is forming between the U.S. and China. And investors are nervous because they fear the Federal Reserve, faced with a resilient economy and high inflation, may need to push the economy into a deep recession to control inflation, causing more bleeding in their portfolio.
Companies are also nervous because they feel they won’t get the funding they need and must preserve cash now to extend their runway, sacrificing growth. The start-ups are also seeing more down rounds and getting additional dilution. And like investors, they are nervous about a deep recession.
The coming together of these fears is hindering major growth initiatives and making companies focus instead on increasing efficiency and cost-cutting.
VC funding of start-ups, already down 17% in 2022, is likely to be even lower this year. Follow-on money (series B and beyond) will be especially challenging for many start-ups. On top of this, while the dry powder in the existing funds is still substantial, VC's own fundraising nose-dived in 4Q22.
However, our view is that we are close to the trough of this market malaise and 2023 will be a transition year.
We believe the funding and valuations will become more reasonable and companies will transition to a stronger foundation with a better cost structure. Recent layoffs in the tech sector also ease the tight and expensive labor market for startups. Furthermore, this realignment will also work as a “sifting” mechanism with weaker companies dropping out as they fail to get funding. As a result,2023 will become the public-market equivalent of a “stock pickers” year vs the rising tides of 2020-2022. We believe as a thesis-based venture firm, we have an advantage in this since we do not follow a theme-based investing and select our own focus areas.
Our research shows that building resilience and infrastructure in the country will continue to be a dominant theme in the economy. The supply chain needs to be strengthened and logistics needs to have the resilience to avoid the backlog of container ships that we saw in the past year. We are also seeing increasing innovation in robotics, making them more versatile for more industries.
At the same time, companies are heavily focused on improving efficiency and creating cost advantages. AI innovations, including Large Language Models like ChatGPT, couldn’t have come at a better time and have the promise of significantly increasing productivity, especially in content-driven industries.
Inflation has been a major tailwind for the automation push as the companies can only pass so much of the cost to customers before their sales drop. A second tailwind is the continued tight labor market. These are the themes we identified last year and are not fully playing out.
On the geopolitical side, the increasing tensions with both Russia and China have pushed the U.S. to increase its military and defense capabilities, especially as military aid to Ukraine has depleted some of our inventory. This is a decade-long trend not just for the U.S. but for the EU as well, to build a stronger foundation for its defense systems.
Based on these macro trends, we see the biggest investment opportunities in the following sector for the next five years:
Supply chain, logistics, and deliver
New applications of Neural Networks and LLM
Automation and robotics platforms
SMB optimization and productivity
Healthcare technologies and Digital Health platforms
Defense and cyber-security
Inclusion platforms expanding demographics of digital and financial connectivity
In the next few months, we will publish short thought pieces on some of these sectors. In the meantime, please give us your thoughts and feedback. We’d love to hear from you.