Navigating Challenging Times: AI's Rise Provides Unprecedented Opportunities For Venture Capital Investors

The past year has been difficult in venture capital, as high interest rates and a volatile macroeconomic environment drive investor uncertainty, lower levels of funding, lower valuations, and decreased performance. For the rest of 2023, we will likely see conservative deal volume while portfolio companies will focus on capital efficiency, cost reduction and productivity instead of rapid growth. Despite these headwinds, VC firms will be paying close attention to rapidly evolving fields like AI, which will have sweeping implications for many industries – as well as how employees train and work.

There has been no shortage of anxiety around AI, and job displacement is among the top fears. But it would be a mistake to underestimate the number of jobs AI will create – as well as the amount of efficiency and productivity it will enable – and VC firms will be watching these shifts closely. VC firms are also on the lookout for sectors that are ripe for disruption, such as property technology (PropTech). Considering the trillions of dollars in assets in the real estate industry, it’s surprising that tech solutions for property investors have historically lagged other fields. This won’t be the case forever.

Although VC firms are confronting many challenges this year, it’s vital to navigate these challenges without overlooking opportunities. The firms that find this balance will have a competitive advantage in 2023 and beyond.

A significant pullback in VC funding

VC firms experienced an extremely weak start to the year, with quarter-to-quarter deal flow collapsing by more than 53 percent in North America and exit value plummeting by 48 percent. Index return performance has fallen off, too: by 10.4 percent and 5.9 percent in the expansion and early stages, respectively. At the end of 2022, total index returns were down a painful 20 percent, and exit values have fallen as well.

Crunchbase reports that global VC funding plunged from $47.8 billion to $21 billion year-to-year – a 56 percent reduction. Every funding stage saw severe contractions: seed (50 percent), early-stage (48 percent), and late-stage (62 percent). In a recent report, Preqin summarizes the situation for VC firms and their portfolio companies: “The first quarter of 2023 was yet another slow one for venture capital in terms of fundraising activity, deal flows, and performance indicators.” Beyond high interest rates, VC firms have dealt with a series of economic jolts – such as the banking crisis earlier this year.

VC firms are understandably cautious right now, and this will be reflected in deal volumes and funding levels over the next six months. However, we are also witnessing the rise of revolutionary technologies like AI and the absorption of AI into many sectors such as EdTech and PropTech. In other words, VC firms can find plenty of value if they know where to look.

Anticipating the economic impact of AI

Just two months after its release, ChatGPT hit 100 million monthly active users – a record for the fastest-growing consumer app in history. The surging popularity of ChatGPT has fueled the race to implement large language models (LLMs) among tech giants like Microsoft, Amazon, and Google. At the end of May, the value of Nvidia briefly surpassed $1 trillion after the company beat earnings and projected much higher demand for its chips, which are essential for generative AI platforms such as LLMs.

As VC firms and portfolio companies contend with grim financial conditions, the blistering pace of AI development offers a more optimistic glimpse at the future. Beyond the creative and disruptive AI-native startups that are quickly entering the space, it’s likely that the negative economic effects of AI will be counterbalanced by the advantages. For example, job losses caused by AI (in content creation, accounting, customer service, and so on) will be offset by new jobs, such as prompt engineers, AI trainers and auditors, data ethicists and annotators, and many others – some of which we can’t possibly anticipate.

AI education will see dramatic growth as students and employees realize that familiarity with the technology offers a major competitive advantage. To take just one example, Springboard (a Telstra Ventures investment) is integrating AI education with its courses on software engineering, data science, UI/UX, cybersecurity, and other fields. At a time when over three-quarters of employees say they’re willing to “learn new skills or completely retrain,” companies should provide professional development opportunities focused on the most dynamic, fastest growing field in tech.

Successful VCs find value in unexpected places

Although VCs that overlook AI will fall behind, it’s also vital to search for value in spaces and companies that may not be grabbing headlines at the moment – but which have the potential for explosive growth. For example, banking, financial and property management software targeted to real estate owners and property managers has been gaining popularity for years due to historically poor solutions and banking tools in the real estate sector. When a multi-trillion-dollar sector is underserved by the available software solutions, this represents a major investment opportunity.

It’s no surprise that companies like RealPage, Yardi, and AppFolio swept into the high-end and midmarket vacuum in PropTech, and we’re now seeing the emergence of low-end software providers such as Baselane, DoorLoop, and Hemlane. Just as Shopify came to dominate the low end of the e-commerce SaaS market (with Salesforce, Oracle, and others occupying the high end and midmarket), these innovative PropTech companies may end up leading equity value creation in an exciting market. Moreover given the amount of data that these more SMB platforms have, there are huge opportunities to leverage AI in their solutions to provide better automation, analytics and advice to their customers. The VC firms that are capable of unlocking this type of value will be in a stronger position to navigate economic volatility this year, and targeted investments in growing industries will help them build a more robust long-term portfolio.

There’s no question that VC firms are facing immense obstacles right now, and investors shouldn’t expect an overnight turnaround. However, with Nasdaq rebounding this year (~30% YTD), relative to its losses in 2022 (-33%), recent IPO success of CAVA and filing of Klavyo, and the recent M&A activity of Adenza and Cvent, the next 1-2 years could be among the best times to invest relative to the last 3 to 5 years. Moreover, we’re also entering a period of unprecedented technological change. It’s difficult to predict what the next few months of AI development will look like, never mind the next few years – and many industries are on the verge of disruption. All the problems of the last 18 months aside, this is an exciting time for VCs and the companies they support.