Venture Capital Benchmark Q2 2023

US, Europe, AND Latin America


It’s always darkest before the dawn

The phrase “it’s always darkest before the dawn” has literal and psychological meaning. Penned by Thomas Fuller, an English theologian, in 1650, he meant that literally the darkest moment of the day is just before the sun peaks its head over the horizon and illuminates the sky. However, the phrase has gained popularity in the centuries since as a rally cry to motivate pioneers to overcome monumental obstacles with seemingly no end in sight. The phrase alludes to that often just before massive triumphs, people face their greatest challenges. That very well may be where we are today for startups across the world.

From hundreds of conversations we have had this past quarter with founders, investors, and ecosystem members, a common thread continues to arise: founders are resilient by nature and strive to achieve success, but the road, especially this past year, has been difficult. It’s no secret market conditions have been unsupportive for exponential growth, and many founders find themselves weathering the storm rather than taking massive risks.

We are confident the founders that are able to survive and continue forging ahead will be handsomely rewarded. We have already seen startups fold over the past couple quarters, and unfortunately we expect more will do so. For the founders who build companies grounded in product, with lean teams and positive unit economics, and foundations to scale when capital is more readily available - they will grab market share and expand at record paces. We are excited for the future and to support these generational companies. 
Welcome to our Quarterly VC Benchmark Report, where we analyze all of the startup and investing activity over the past 3 months and stack it up against what we saw in the previous quarters and years. We scan across the US, Europe, and LatAm to bring you the best insights, be it you are an investor, founder, or just interested in the startup investing space. Let’s dive in.

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Trends to watch

The biggest headlines

Plenty happened in Q2 in the startup world and we will break it all down for you. Some major headlines that are worth highlighting include: 
The bar continues to be raised for startup performance to secure funding.
A mixed bag of macroeconomic indicators spells cautious optimism or more challenges ahead, depending on who you ask.
Artificial intelligence is moving at a speed no one can keep up with and investors are left trying to sort out value from hype.
Deal activity in general dips slightly but holds firms with prior quarter performance.
The bond between Madrid and Miami is stronger than ever and the fundraising world continues to become more global.

Many startups right now need perspective on where we are in this market cycle and what lies ahead. We will provide some clarity around this topic as we break down where we are headed in the second half of 2023. 

Founder perspective

Juan Ignacio, Founder of Boopos and one of our portfolio founders, has his finger on the pulse regarding startup performance and fundraising. He is in the business of helping startups get acquired by providing M&A financing. Juan had this to say when asked about what investors are looking for in startups to purchase:

“Our direct exposure to the digital M&A market allows us to perceive first-hand changes in investor sentiment. For example, this quarter we noticed that investors are bullish about SaaS, which has remained a strong performer through the ups and downs of the past 4 years, whereas e-commerce and related businesses have reverted to the mean, attracting a smaller share of venture money recently. Overall, this remains a buy side market and therefore founders and business owners should expect moderate valuations. On the other hand, there is healthy demand for digital services, so perhaps it's a good time to focus on executing instead of fundraising. The hiring environment also points in that direction, with lots of strong talent looking to join new projects. Interestingly, many companies are pushing for a full return to the office, and that's where ecosystems like Miami are increasingly important as tech people continue to flock to the city.”

Juan Ignacio

Juan provides some key points of advice: focus on execution and people. The companies that can effectively deliver on their product and growth in between fundraises, while assembling the teams to execute on their long-term visions, will have the best chance to raise capital when the time comes. 

Trends to watch

The biggest headlines

 For the founders and investors that have witnessed multiple market cycles, they know that massive opportunities exist today, especially given the technical advancements available at founders’ fingertips. Many massive, generational companies were founded during recessions or massive market displocations. Chamath Palihapitiya from Social Capital comments on the phenomena in relation to high interest rates, a common contributor to recessionary environments when equity markets recede. Ultimately, he concludes that technology startup success is most likely to occur when companies exploit massive technology innovation during periods of higher than average interest rates. The former part of this tech startup equation may come in the form of leap forwards in alternative intelligence (AI) and reduction in cost of computing power. AI is finally realizing its potential as a horizontal tech enabler to disrupt virtually every industry and make products better.

Founders are rushing to incorporate AI into their value propositions while VCs debate where in the AI value chain they should invest, and which portions are most likely to win. The pace of innovation in the space is frightening for many, especially with the onset of ChatGPT by OpenAI and the rapid advancements of their computing models that huge enterprises are now adopting. This pace is so fast that many well-regarded AI experts are calling for a 6-month pause on experiments in AI beyond GPT-4 so regulation and the public can catch up and prepare for the progress (or regress) that is upon our doorstep. However, innovation is hardly containable, best exemplified with the recent launch of Auto-GPT which can autonomously run AI prompts to achieve an end goal with little to no human intervention. Combine that with the marginal cost of energy and computing going to zero, founders have unbelievable technological resources available to them to build incredible products.

Q2 2023 in a nutshell

For a year now, relatively stable funding volume

Despite how headlines evolve, numbers and figures tell a more concrete tale. 2021 and early 2022 were highlighted by extreme levels of overexuberance, where funding volume reached unsustainable heights and startups received capital with little connection to their quality of product and customer base. This produced $100B+ quarters with valuations climbing into the stratosphere, often despite lack of traction. 

Source: pitchbook

This hype has come back down to earth as of Q3 2022, and since then funding volumes have stayed relatively consistent. Q2 2023 landed at $59.4B across the US, Europe, and LatAm, which was down just -3% from last quarter. Over the past year, funding volume across quarters has stayed within the band of $56.7B - $65.3B, just an $8.6 margin. This consistency shows promise that economic conditions are improving from their lowest levels and we may have seen the worst of this cycle.

VC perspective

from TheVentureCity

We have always been, and will always be, founder first. However, we cannot support every startup that comes through the door. Startups today must build lasting companies with products that customers demand and struggle to live without. 

As Elizabeth Yin, co-founder of Hustle Fund, aptly put it:

“2021 prolonged the lifetime of startups that would've ordinarily died in a ‘normal’ market. Companies with no product-market fit. Many of these companies were given an extended lifeline with valuation markups.”

Elizabeth Yin

When founders speak about today’s fundraising experiences and the challenges that come with them, they are absolutely correct that receiving capital now is tougher than a year ago. However, one must decipher the great companies who have reached product-market fit and raised rounds because they have sustainable, repeatable business models from the companies that would have not existed today without the bar being lowered 1 year ago. 

When we identify those startups that are building generational products, we go to the ends of the Earth to ensure they thrive.

Advice from the greatest accelerator on the planet

Lessons from Y Combinator

Nine months ago we published a living document: “Actionable tips for surviving an economic downturn” and many of the lessons are still relevant. We co-wrote this with our founder and investor network so founders could crowdsource best practices and ideas to survive the impending fundraising winter.

We have revisited those lessons, and drawn upon new inspiration from other trusted voices within our space. Y Combinator published YC’s Essential Startup Advice, lessons that ring true and are a must-read for any early stage founder in any market cycle. There are many great nuggets in the guide, but some of our favorites are: 

Build something people want
All startups are badly broken at some point
Write code - talk to users
Pre-product market fit - do things that don’t scale; remain small/nimble
Ignore your competitors, you will more likely die of suicide than murder
Be nice! Or at least don’t be a jerk
Get sleep and exercise - take care of yourself

Macroeconomic commentary

A mixed bag leaves investors guessing

Key market data puts the bulls and bears at odds

Entering 2023, the prevailing market sentiment was generally that trouble lies ahead as the Federal Reserve combats inflation. Few investors, if any, could have predicted what would transpire over the next two quarters. Fast forward 6 months (as of June 19, 2023) -  the S&P 500 ended 19 percent higher than a year ago, 23 percent above its low in October, and roughly 8 percent away from a record high. So what is driving this rally? 

Unemployment sits at just 3.5% and consumers are spending more (up 1.3% in June), which helped keep corporate profits afloat and surprised investors in Q1. Inflation has moderated (just 3% in June), and the Federal Reserve opted for the first time in more than a year to leave rates unchanged at its meeting in June. Skeptics have been calling the recent positive trend a bear market rally, which will dive back down after this positive head fake. However, bulls are still optimistic since GDP increased by 2% in Q1 (above estimates) and the labor market continues to add jobs at a pace above pre-pandemic levels. 

There are certainly still reasons for caution and pessimism. Inflation remains relatively high and above the Fed’s 2% target. Bank failures, corporate bankruptcies on the rise, and likely more interest rate hikes give reason to consider this rally short lived. More market data will give us better clarity on what to expect in public and private markets. 

Beneath the surface lie true insights

Analyzing key drivers of performance can give us an idea of what’s ahead

On interest rates: 
Interest rates are typically hiked when the Fed believes the economy needs to cool down (excessive and atypical growth can be unsustainable) and inflation is too high - both were true after excessive monetary stimulus post-COVID. Since the beginning of 2022, the Fed has successively hiked rates at each meeting by a cumulative 5.00% to achieve a target rate of 5.00 - 5.25%. June 2023 was the first time in over a year the Fed did not hike rates, signaling to some investors that the worst is over. 
However, that may not be the case. Inflation is still above the Fed’s target and energy prices have been persistent, rising 5.3% in May 2023. Considering unemployment and labor fundamentals have remained strong, the Fed is forging ahead and forecasting two more rate hikes this year. This equates to a median projection among Fed officials of 5.625%, or within the 5.50-5.75% range. This hiking is designed to bring down inflation, but it will likely impact other vital portions of the economy.
Below is the “dot plot” of how Fed officials predict where interest rates will end over the next few years.   
On inflation:
Inflation remained stubbornly high for months after the Fed started hiking rates. Fortunately, it began to materially subside beginning in late 2022, and that trend continued for the first two quarters of this year. As of March 2023, an important reversal occurred that we haven’t seen since two years prior: wage growth outpaced inflation. In June 2023 the gap between wage growth and inflation further widened: wages grew 5.6% and inflation climbed only 3%. This reversal is critical because it means consumers have increased purchasing power and are incentivized to spend more on goods, which stimulates the economy.
The Federal Reserve’s rate hikes thus far have proven to be successful without plunging the global economy into a deep recession. We will be monitoring this closely as it has direct effects on private market performance and confidence.  
Other key price categories within the economy have seen dramatic drops. Energy prices have declined since the second half of 2022, and shelter inflation, which has been notoriously sticky and unyielding, is also starting to ease. Shelter inflation typically lags broader market conditions, so we expect to see more return to normalcy, especially since the Fed has indicated more rate hikes are in the forecast. 
On Credit:
Interest rate hikes have been effective in tempering inflation. However, they have also been effective in reducing credit extension. Credit originations are near record lows since capital is relatively expensive compared to a decade of zero interest rates. The proof comes through in the data: Lending levels are near those of 2009 ($31.3B of a leveraged loan market of $1.4T). For reference 2021 YTD was >$160B. This disparity produces two key takeaways: 
When the return on debt becomes more expensive, this translates to a higher required return on equity. When interest rates were low, limited partners and institutional capital poured into private equity and VC considering the risk/return profile of the asset class became relatively more appealing. With higher rates and private credit becoming more attractive, private equity and VC must produce high enough returns to justify its place in portfolio asset allocation. 
Lenders have become increasingly risk-averse, especially with corporate bankruptcies on the rise and the failure of three banks just last quarter. 
It will become harder for private market companies at earlier stages to secure venture debt and loans. The bar for credit worthiness has been raised as the cost of capital has increased. 
The market Cycle:
We do not claim we can predict the future, but we can look at where key market metrics stand and how they correlate to what may lie ahead (compared to historical examples). The stock market peaked in December 2021, hit a relative low in October 2022, and since then has made a consistent climb back towards its all-time high. From peak to trough it took slightly over 9 months, and this market cycle has now lasted 18 months and counting. Historically, bear markets last 14 months, but recovery periods are based on a multitude of market factors and general investor confidence. 
We found the chart below interesting in comparing stock market performance with consumer confidence. Investors, especially when driven by emotional sentiment, tend to make poor choices and invest at the top and sell at the bottom. We consider this idea when deploying our own capital and how limited partners time their allocations with VC funds. As public markets improve, that can impact private market investors’ confidence and become more open to investing their dry powder.
Private market cycles typically lag the public markets by a couple quarters. There is no telling where we are headed from here. However, given the historical context of market performance and where inflation, interest rates, unemployment, and GDP stand, we may be in for a softer landing than anticipated. 
State of startup ecosystem

Where are we now, and what can we expect going forward?

The ultimate question based on this analysis: where are the private markets headed from here? As we stated, public markets tend to feel the immediate effects of changing market data, while private markets are more insulated and feel the effects of large swings with a lag. In the coming 6-12 months, we can make reasonable predictions based on the data available and what has happened historically: 
Late stage and growth deals are dependent on strong IPO markets where investors foresee opportunities in short-term performance. A rising stock market gives better opportunities for public market liquidity. Late stage companies are also dependent on a cheap cost of debt to facilitate M&A, and we are in a cycle now where less credit is being extended. Flat or lower interest rate forecasts will indicate to corporations and private equity investors that the timing is more favorable for these types of exits. However, the Fed is not forecasting this case for at least 3+ quarters.
Inflation is stubborn and will continue to persist in the short term. Although the Fed is hiking rates less aggressively, their guidance indicates that inflation must come down further and it is taking active measures to readjust where the economy should stand.
Early stage investors need to see appetite in late stage before ramping up deal making. Once late stage investors are more interested in deploying capital, early stage investors will follow suit as they will feel more confident their investments will be marked up 1-3 years after investing. 
LPs will rotate into risk assets when income-generating assets become less attractive. We are seeing this phenomenon happen slowly in the public markets. The jury is still out on when institutional LPs will deploy in the private markets at increased levels. 
Founders at early stages can feel relieved as a lot of the worst has already happened, but the road to recovery could be many more quarters.

VC perspective

Miguel Armaza is a Co-Founder and General Partner at Gilgamesh Ventures. He is well versed in market movements and how they affect private market transactions from his prior work at large banks Citi and MUFG. He gives his perspective on what we have seen recently and what is to come: 

Data Deep Dive

What to look for

Retention and expansion

In this market environment, we are hyper-focused on acquisition strategies and cash burn. Too often we see startups spending too much to acquire what they perceive as significant customers, only to fall short and have to go back to the product drawing board.

David Smith, Chief Data Officer at TheVentureCity, speaks to how he views long-term startup success from a data perspective. When he looks at startup data right now, he pays particular attention to customer retention and expansion. 

If founders spend time on their most accretive channels and formulate product around retention and expansion (ideally through product-led growth), then David sees strong opportunity to raise further capital rounds due to customer stickiness. 

Fundraising by Geography

US VC landscape in Q2 '23

More of the same

Founders across the US are looking for a return to 12-18 months ago, when capital was plentiful and investor appetite was abundant. There are reasons for optimism, but those reasons have yet to translate to fundraising numbers. The US produced $41.5B in fundraising volume across 3,449 deals last quarter, a -11% drop QoQ and -43% decline YoY. 

Source: pitchbook

Despite these unencouraging figures, the US VC ecosystem has remained relatively flat since Q3 2022 and average deal size ($12M) is larger than two and three quarters ago. With the improving macroeconomic data and thawing of public markets, some private market investors are looking at ways to take advantage of this relative market bottom.

VC perspective

Kyle Stanford, Lead Analyst at Pitchbook, engrosses himself with how the VC market is developing, and how that translates to metrics. He gives his perspective on what is to come given recent events and how macro trends are developing: 

“Q2 was a calm quarter in VC, especially compared to Q1 that had the collapse of Silicon Valley Bank. Deal value is still low, and valuations are showing more strain than we have seen through the slowdown. The poor exit environment, especially for IPOs, is hampering the dealmaking market because capital is sitting stagnant at the top of the market. During the high exit value years of 2020 and 2021, more than 80% of the value created was generated through public listings. The largest companies in VC need a strong IPO market to unlock the returns trapped from investors and LPs. Without returns, there is less capital to be recycled into the industry through fundraising commitments, which could lead to slow deal activity down the line. We are looking at the next six months as very pivotal for the market. Should inflation balloon back up, and interest rates continue their rise, we should expect a swift decline in dealmaking with the worst conditions. Should headwinds subside, we could see a revival of exits which will, in turn, drive dealmaking activity within the market.”

Kyle Stanford
Europe VC landscape in Q2 '23

Europe starts to rebound

In a turn of events, European fundraising activity ticked up in Q2 and was higher than the previous 2 quarters. Q2 saw $17.2B poured into startups across 1,591 deals, a 19% increase from Q1 and 9% increase from Q4 2022. This figure was supported by a few mega deals, particularly Verkor and H2 Green Steel, which raised north of $2.1B and $1.6B, respectively. Although Q2 underperformed on a YoY basis, that isn’t the takeaway here. 

Source: pitchbook

Despite the Russian/Ukrainian conflict, less funds being raised in the region, and an energy crisis, European fundraising has stayed resilient and even rebounded in Q2 2023.

VC perspective

Despite the uptick in performance, European investors remain cautious and thoughtful in how they deploy capital. Ricardo Jacinto, Partner at Shilling VC, gives his take on the state of European startup activity: 

“Q2 has still been very cautious on the investor side with many companies trying to find alternatives to extend runway to get better metrics and overcome this market downturn. A strong sign of this trend is the focus by large funds on companies in earlier stages, creating a bit more competition in the pre-seed and seed stages and not a relevant decrease in round sizes and valuations. There are a few exceptions of companies performing quite well even in later stages, also AI has been performing quite well, where big rounds and spectacular valuations are still happening.”

Ricardo Jacinto
LatAm VC landscape in Q2 '23

Finally some good news for Latin America

Since Q2 2022 the narrative for LatAm has been consistent: worsening market conditions led investors new to the region to pull out in favor of sticking to what they know: investing locally. Hopefully, we are seeing that trend reversing and Latin America gaining back the fervor of the investor community. 

Source: pitchbook

Q2 saw investors deploy $650M into Latin American startups across 117 deals, a 76% jump from Q1’s volume. This figure is still slightly down from Q4 and approximately a third of what we saw invested one year ago, but progress is progress.

What is encouraging is there was not a large concentration of deals where one or two fundraises skewed the data dramatically. There was only one company that raised nine figures in Q2, and outside the top 10 largest deals, all other fundraises were <$20M. Decentralization across fundraises tells us that this increase in fundraising is potentially sustainable. 

Ecosystem member perspective

Andy Tsao, Head of Global Gateway at Silicon Valley Bank, has been active in supporting Latin American startups for almost two decades. He gives his perspective on the LatAm ecosystem and its propensity to come back, based primarily on the resilience of founders in the region: 

South Summit Spotlight

Miami and Madrid together in one room

TheVentureCity caps off South Summit with a bang

Laura González-Estéfani, Founder and CEO of TheVentureCity, has long realized there is a special bond between Miami and Madrid. In Refresh Miami’s article, she outlines how she landed and built TheVentureCity in Miami, with Madrid as our European hub. Both cities are Spanish-speaking, abundant with talent, and share a mutual ecosystem where people in tech find themselves bouncing back and forth between the two cities. 

South Summit, one of Europe’s largest and most important tech conferences, occurs every year in Madrid. We always enjoy seeing friends and familiar faces come into town and catching up. This year we took South Summit to the next level considering it had been three years since we had seen our entire European ecosystem in one room together. 

We gathered the entire TheVentureCity team, founders, investors, and others from the ecosystem  to throw a tech party with over 300+ attendees. It was an amazing way to cap off the conference and we hope to host you again in Madrid next year!

Women in VC

No improvement, but resilient

When the rest of the market sank, female-founded companies held firm

Sometimes no news is good news. When the rest of the US market was down -11% from Q1, female co-founded startups raised $6.7B across 689 deals, the same volume as last quarter. This indicates some level of progress in relation to the industry, but there is not much to celebrate. So far in 2023, female co-founded companies represent 18.1% of all US VC dollars raised and female founded teams have raised 1.9% of the total US pie, down from 2.1% in 2022. 

Source: pitchbook

The main takeaway: female co-founded companies have not seen much negative change over the past 3 months, but clearly little has been done to more actively support female founders.

VC perspective

Despite the generally negative news around capital deployed for female founders, there was a nugget of inspiration in the space. A true trailblazer and veteran, Itxaso del Palacio, General Partner at Notion Capital, has been an active investor in the European VC ecosystem for over a decade. We are happy to see that she and her partners successfully raised a $300M Fund V, even in this difficult fundraising environment. She was also promoted to General Partner, a huge milestone! She comments on that experience and how she will go about deploying this new fund over the next 3 years: 

“Last week we announced the close of our 5th flagship venture fund at $300 million to invest in early-stage business software opportunities across Europe. While we closed the fund at its ‘hard cap’, one shouldn’t assume that the fundraise was easy. We are in a challenging market with limited exit opportunities and with many investors that are overexposed to venture. In our case at Notion, we believe that our consistency and focus were critical to the successful raise. For the last 15 years, Notion has been focused on backing business software companies at Series A. Even in strong markets when money was flowing nicely, we didn't raise massive funds and we didn't play in large, overpriced rounds; and more importantly, we have continued to raise our funds on 3-year cycles (not in shorter cycles taking advantage of the capital available in the market). This consistency has helped us build a stable portfolio as well as trusted relationships with our investors, who continue to support us over the years. 

In terms of the deployment of the fund, we are strong believers in the opportunity in business software in Europe. The European ecosystem has evolved over the years and today Europe is home of some of the fastest growing companies in the world. Some of these companies such as Paddle, Yulife, Mews and GoCardless are already in the Notion portfolio and we are committed to backing the next generation of global unicorns from Europe.”

Itxaso del Palacio

Industry Spotlight: Artificial Intelligence

Breaking down where we stand in the AI revolution

Moving at the speed of light

Artificial intelligence (AI) is moving at a speed nobody can keep up with. What has been largely a lab project for the past two to three decades is now finally taking a major foothold in consumer and business applications.
Just in the past year or two we are seeing tremendous inbound interest from founders and investors in the space because the tech has reached a point of massive commercial applications. Some notable events that have happened recently include:
Some more notable event that have happened recently include:
OpenAI’s launch of ChatGPT and its record milestone of fastest application to reach 1M users (over 100M users now)
Other large tech companies entering the large language model (LLM) space - Google, Meta, Apple, etc.
An open letter signed by important tech players against the further acceleration of AI (at least for now)
Microsoft’s $10B investment in OpenAI - tying its financial interest to one of the most innovating companies in the space
The creation of automatic chatbots (AutoGPT) that further accelerate productivity and task completion
All of these events have happened in just the past nine months. The rate of development and adoption only continues to accelerate, and we will likely see the technology proliferate in all aspects of business and life as we know it. 
Fight for supremacy

A mix of incumbents and new entrants are catapulting the space forward

As has happened with other major technological advancements (internet, mobile, automation), there is an eternal struggle between incumbents looking to upgrade their own operations and new entrants looking to build superior products with novel tech to capture market share. We are seeing this play out in front of our eyes with some notable players: 
The entrants list could go on for 100+ more rows. In just the past year, thousands of AI-focused companies have entered the market to disrupt value chains and provide more efficiency and value to companies and consumers. 
Marc Andreessen writes in his article “Why AI Will Save the World” about the concept of the “Baptists” and the “Bootleggers”. He sees parallels between AI and Prohibition, where self-interested groups did what they could to push their agenda on the public, and in some cases profited off restrictions so a small group of people control what the public wants. The parallel to AI is that through regulatory and large corporate interference, progress will be halted and control over this significant technology will be restricted to the wealthy few, when in reality it belongs to the masses. 
As investors ourselves and because we are founder first, we encourage competition to bring down the costs of production so end consumers are best off. To achieve this, the eternal struggle between corporations and new entrants must not be interfered with by allowing founders to freely build the companies of the future.

Founder perspective

Anna Anisin, Founder of FormulatedBy, is a seasoned 3x founder and deeply knowledgeable about the startup space. She speaks to the importance of building with AI and the opportunity the tech presents for founders:

Sorting fact from fiction and value from hype

Where does the true value in the AI space lie?

Quite literally, the billion dollar question among investors in the AI space is: what is valuable and what is pure hype? There is also fear of investing in indefensible companies that stand to be wiped out with a new OpenAI product update (ChatGPT wrappers, companies not solving material problems, etc.). Investors want to avoid being part of the herd and investing in what leaders in the space are already calling a bubble. However, they are equally fearful of missing out on a moment in time where early leaders in the space are emerging and tremendous value is already being created. 
We are committed to staying grounded in our values of only investing in companies which solve real problems and build defensibility through product market fit and retention-driven data. Long-term value is created when customers are satisfied over a repeatable basis and incorporate a company’s product into their regular activities and lives.
We have identified a couple approaches in how to identify these opportunities:
The market approach: AI Leapfrogging
We drew upon Morgan Beller, General Partner at NFX and thought leader in the AI space, and her idea around AI leapfrogging to present an idea for outsized value to industries that desperately need it. Her concept of leapfrogging is to utilize new technology in ancient industries that have struggled to innovate to jump prior technological advancements and directly to the cutting edge. Some examples of this include: emerging markets skipping desktop and going directly from landline to mobile, and markets that jumped from cash to mobile payments/crypto and skipping credit. 
We agree with Morgan that AI presents a massive opportunity for certain industries to leap from analog to the AI age, effectively skipping the vertical SaaS portion of the tech advancement curve.
What is critical when placing bets with this mental model in mind are: which industries are still analog to this day and why have they not made the conversion to SaaS? If the answer is they are better off without SaaS and change is unnecessary, it’s best to move on to other spaces. In this case, SaaS did not tip the scales and present more potential value than the burden of change. 
However, if the burden to change vs. potential value realized equation is potentially tipped in favor of the latter due to the accelerated efficiencies and speed of AI, and there is appetite to evolve, then AI may present a compelling value proposition.
AI leapfrogging presents a favorable way to invest in AI because it is grounded in value to the consumer, not incremental advancement of tech. Building tech for the sake of building something cutting edge is not a sustainable path to profitability; the end consumer must be in mind. If companies build AI products in industries that are still analog, but are eager to adopt new tech if the value outweighs the burden to change, then those are spaces where we are interested in investing. 
The product approach: trained AI on top of LLMs + proprietary databases + reinforcement through human feedback
A core piece of investing in AI is establishing product defensibility. This is incredibly difficult to identify as the space is changing so quickly. However, we asked a friend and expert in the AI space to weigh in and he enlightened us on a novel way to approach this problem. 

Founder perspective

Marcos Sainz is the CTO of Returnly (acquired by Affirm), and one of our esteemed portfolio founders. He is an expert in the AI space and elaborated on how best to approach investing in companies in this market environment: 

"In the AI investment landscape of 2023, it's crucial to understand what lies behind the term 'AI' in the startup you're considering. Are you funding the training of next-gen foundational models with internet-scale datasets? If so, remember that your capital could largely be going towards capex, and the cost of training these models is likely to drop significantly within a year. Alternatively, are you funding a thin wrapper around an OpenAI API? Consider that foundational models from OpenAI or Bard could close the value gap within a year, rendering many of these wrapper companies or projects obsolete.

The sweet spot for VC money may lie in companies implementing Retrieval Augmented Generation (RAG) by leveraging proprietary databases, and creatively using supervised fine-tuning (SFT) and reinforcement-learning with human feedback (RLHF) on top of powerful open-source foundational models, like IIT's Falcon-40b. The magic lies in the creative combination of the best foundational models with proprietary datasets and human-in-the-loop. That's where I'd place my bets in the AI sector today."

Marcos Sainz
We agree with Marcos’ sentiment - when companies can build defensibility around fine-tuned models due to access to proprietary data, all while incorporating this into products that consumers find incredibly useful (and evident by strong retention), then a moat can be developed in this competitive space. 

AI is moving at the speed of light, and we are excited by future advancements in this already fascinating space. By using market and product approaches in a complementary way, we aim to find the best founders building useful products in spaces that desperately need more efficiency and better customer experiences. 

Fundraising by Stage

Seed Funding in Q2 '23

Seed stumbles slightly

In line with the rest of the VC market, seed saw a slight decline in fundraising volume and deals. Seed deals represented $4.6B in Q2 2022 across 1,229 deals, down -9% from Q1 and nearly half of volume one year ago. Despite the drop in volume and deal count, it wasn’t all bad news for seed companies. 

Source: pitchbook

Seed fundraises saw a lift in average pre-money valuations ($16.9M) and deal sizes ($3.8M) QoQ. This tells us something: for the seed deals that do get done (of which there are less), they are getting the valuations they command due to strong investor appetite at this portion of the VC market. 

VC perspective

Jenny Fielding, Co-Founder and Managing Partner at Everywhere Ventures, is one of the most experienced investors in the seed space. She has 300+ investments as the first check into the company and has seen several market cycles. Here she comments on how this one is shaping up:

“The first half of 2023 was rocky for founders raising capital, with growth rounds feeling it most acutely. Investors with large pools of capital to deploy concentrated their bets into the top 5-10% of companies. So in our portfolio, that played out with a couple of our growth stage companies raising monster rounds while the rest were hard-pressed to raise. Many companies that need to raise have been delaying the inevitable pain. The second half of 2023 into 2024 will likely be tough for some of these companies. 

All that said, early stage continues to plug along with pre-seed and seed deals, our sweet-spot, not seeing a huge impact despite the data showing a steep drop in capital being raised. We have seen valuations come down 10-20% but not much more which is either good news for early stage founders or just a lagging indicator of what’s to come.”

Jenny Fielding

Early Stage Funding in Q2 '23

Series A and B companies still weathering the storm

This market has proven unforgiving for companies beyond the seed stage. Series A and B investors have continued their retreat from early 2022 levels and continue to deploy less capital into new companies entering early VC stages.

Source: pitchbook

Companies that have received pre-seed and seed funding rounds are elongating runway and raising extension rounds, plus anything else they can fathom to weather the storm when capital becomes more readily available.

Investors deployed $8.2B across 338 deals into Series A and B startups, down -15% from Q1 and -62% YoY. Average deal value was actually up QoQ to $24.2M, but that was the only bright spot in an otherwise difficult fundraising environment.

VC perspective

Andy Areitio, General Partner at TheVentureCity, is on the ground floor speaking with early stage founders every day. He acknowledges the difficulty in the market, but from his conversations foresees opportunity on the horizon: 

VC perspective

Dami Osunsanya, Co-Head of Softbank Opportunity Fund, shares many of the same views as our General Partner Andy Areitio. She opines on what she is seeing at early stages here: 

“In the early and early-growth stages, strong companies with outstanding founders ready to create meaningful impact continued to build. Overlooked founders particularly continue to be resilient in this environment given they are accustomed to growing companies under fundraising constraints – as a result, operationally efficient companies with clear paths to profitability emerge. As a generalist fund we’re excited to uncover founders passionate to leverage technology, and innovate in various industries from edtech to sustainability to healthtech. I also continue to be excited about how AI is overlaying these industries to accelerate the technology revolution.”

Dami Osunsanya

Late Stage Funding in Q2 '23

Late stage deals rebound, but the devil is in the details

Late stage deals surprisingly came back in a big way in the second quarter. Q2 produced $21.3B in deal volume across 162 deals, up 139% QoQ. This deal volume is still below the record-breaking quarters of 2021, but still higher than any of the past three quarters.

Source: pitchbook

The reason for this massive jump is a few outliers skewed the data: Stripe’s massive fundraise got reclassified to Q2 from Q1, and Verkor and H2 Green Steel’s fundraises accounted for $10.6B total volume. These 3 deals represented 50% of the quarter’s deal volume - hardly an indicator of future momentum moving forward.

However, one cannot discount that the numbers did not decline QoQ and other factors may indicate there may be positive things to come at late stage.  

Weather outlook: Partly cloudy

A mixed bag of trends spells uncertainty at late stage

The positive numbers at late stage for Q2 can be read in a multitude of ways. For one, we are seeing improvement within the public markets: as of June 26, 2023 the S&P 500 was up 12%, the NASDAQ more than 20%, and Pitchbook’s VC-backed IPO Index up nearly 22%. On the flip side, Series C and D rounds are likely to see the most down rounds moving forward considering there is little investor appetite and these companies are starved for capital.
Positive macro metrics that we mentioned earlier may indicate to later stage investors that this may be an opportune time to deploy dry powder at the bottom of the cycle. However, they may elect to wait for continued positive signaling before taking the jump. The future of late stage does not inspire much confidence for positive or negative sentiment.  

VC perspective

If there is anyone who can help us make sense of late stage investing right now, it is Shu Nyatta, Co-Founder and Managing Partner at Bicycle Capital. He has witnessed the past year of struggles, but sees light at the end of tunnel: 

“The growth market in Latin America has been in a coma for over a year, but the patient is finally moving some fingers and toes. It’s exciting to see companies raising B rounds again; it’s also healthy that some later stage companies are considering down rounds for primary or secondary. A reset is needed – it may seem painful at the moment, but will be healthy for the ecosystem long-term.”

Shu Nyatta

Concluding Thoughts

There remains much to be excited about when evaluating the world of startups. The past year has certainly levied its share of challenges. However, we see reasons for optimism. Macro trends seem to be turning (however too early to say, we will know more in 1-2 quarters) and the public markets are starting to respond. Startup founders are finding creative and novel ways to build their companies with less burn and more productivity (see: AI).

We are seeing some stirring across investment stages where the investment bottom has potentially been reached. Lastly, AI presents a whole new opportunity to develop and fund companies with more attractive value propositions. The past year has been difficult. However, we look to the future with excitement as we believe some of the best companies of the decade are only yet to come.