Navigating The Contradictions: The 2023 Venture Capital Landscape

Written by Adam Nelson, Partner at FirstMark

Amidst the onslaught of Fall tech community events in NY, I’ve had the opportunity to spend time with many of my colleagues in the Venture ecosystem. After a long summer being mocked for Italian vacations, many VCs expected deal velocity to materially increase, but overall most firms’ deployment is still well below historical norms (although here at FirstMark we’ve been quite active, thanks in large part to the approach I’ve expounded upon in this article). The result of this industry-wide reduction in deployment is a glut of dry powder and a meaningful capital gap that only stands to grow as more companies come to market.

Below, I’ve attempted to untangle the factors that are leading to the seeming gap in capital supply and venture round momentum. I’ve also shared our approach here at FirstMark as we adapt to the current environment and continue finding and backing the best Series A founders in New York, Europe, and beyond.

VCs In Hibernation: The Bear Case

Some of the most prolific investors have pulled back significantly on investing. Ironically, in a market with deal prices down significantly and an abundance of dry powder, you would expect a buying frenzy, but the market doesn’t appear to be normalizing (my old friends/colleagues from Tribe Capital arrange the data pretty convincingly here). I believe there are three key reasons this is happening:

Traction is scarce

The obvious move to make amidst a market-wide pullback is to back a new crop of businesses showing meaningful breakaway traction. But, with a couple of notable exceptions, it’s very hard to find true venture scale traction at the early stages in today’s market. While the specifics are subjective, it’s my view that historically, a “normal” Series A included:

• A set of table stakes metrics that included 100%+ YoY growth, $1M+ ARR, and 100%+ net retention on $1–5M of capital raised, as well as
• the diligence on team, tech, meaningful market opportunity, strong differentiation, customer feedback, etc.

Companies with those metrics are now pretty scarce, and most of what you’ll see pricing-wise in the current market are:

• Pre-traction companies with consensus teams still being priced at Series A levels
• AI and a few other “en vogue” sectors where experimental demand still exist
• Non-obvious locations, and vertical markets that historically haven’t been on the radars of venture investors

The interconnectedness of startups helps on the way up and hurts on the way down

Many startups have other startups (of various stages) as their customers, which provides a much-appreciated boost when the market is strong but comes with a much-lamented accelerated decline when the market turns. That means that while the rest of the economy may be avoiding a recession, we’re absolutely experiencing one in the startup ecosystem.

In a market where 120%+ net retention was becoming the norm, we’re seeing a substantial pullback and <100% net retention in tier-one businesses across multiple end markets. Even the best companies are taking their feet at least somewhat off the accelerator and extending that 10x growth achievement from 3–4 years to 6–8 years.

We don’t know where the right pricing is

At some point, we’ll inevitably normalize what a Series [X] looks like, but that day has yet to come.

The only part of the market that seems to be healthy in 2023 is Seed, where multistage firms can still deploy smaller amounts of capital at relatively low risk to their portfolio to buy option value, though I would argue this is not representative of the real market.

Indeed, Seed has been so pressured by that dynamic that current pricing is still much higher than the historical pricing that has driven the majority of returns in that asset class (a continuing debate spanning YC Demo Day pricing to the persistence of returns at these prices).

Similarly, while many companies have had to reckon with the realities of the new market and down rounds are at a multi-decade high, there are cohorts of companies across every stage of the venture ecosystem that still haven’t had to face the reality of a new standard that would put them somewhere between 50% and 80% of their previous valuation.

Many of these companies raised considerable amounts of capital in 2021, which provided them with several years of runway. This has given them the opportunity to shift to a lower gear rather than coming to a complete stop. The unfortunate but important reality though, is that many of these companies, despite their growth, won’t hit their next fundraising milestones and may simply be delaying the inevitable.

A Venture Renaissance: The Bull Case

While all of the above could lead to many VCs checking out for good, it’s undeniable that “great companies get built in down cycles,” and there is so much to get excited about given where we are at this current moment in time:

Compounding innovations will lead to more “Renaissance” moments

Cloud computing and mobile technology developed around the same time in the early 2010s, which led to the creation of trillions in market value and completely changed the fabric of our lives. Technology innovations on their own are profound, but when multiple innovations intersect, they have the potential to create those Renaissance moments that truly feel like magic.

The past few years have seen massive amounts of capital being injected into the market, funding multiple innovation curves that continue to develop at exponential or near-exponential rates. Breakthroughs (like LLMs), while admittedly enjoying their own mini hype cycle, have the potential to dramatically shift the return dynamics of venture scale startups on their own by enabling new disruptive products and changing everything from the cost of building software to distributing it.

It has never been cheaper or easier to start a company

Hundreds of billions of venture dollars have funded innovation over the last decade, from building out infrastructure to new platforms and point solutions — the result of which is an environment in which it is easier than it’s ever been before to start a business, hire across the globe, communicate with that team, and then build on primitives ranging from foundational AI models to compliance-as-a-service for fintech.

The tech ecosystem is extremely resilient

It would have been hard to imagine a more catastrophic set of events to hit the crypto market than the combination of Luna, ThreeArrows, SBF, Binance, and the SEC. We are at a moment where an NFT is more likely to be a punchline than an investment, and the Larry David FTX ads have quickly surpassed Pets.com as the most cringey Super Bowl moment you could imagine.

And yet, 18 months into this crypto winter, Bitcoin has rebounded to a $500bn+ mkt cap. Paypal, Fidelity, and BlackRock have all made major crypto-related announcements in the last few months, and it will still cost you $50k if you want to purchase a Bored Ape. This goes to show that the markets being disrupted by technology are bigger than we ever imagined and have much more staying power than their dotcom crash predecessors.

Consolidation will lead to bigger returns

The last companies standing will find bigger returns because of the market dynamics I’ve described above. The impact of long-term compounding innovation leads to the absolute best outcomes for companies and venture capital. And while innovation continues to compound, either through actual consolidation (M&A) or simply consolidation of the best talent in a given market, these companies may be able to drive the talent and capital density that was hard to come by in the frenetic spread of the last bull cycle.

Products win markets, but people build products, and with many employees sitting with stale valuations and underwater equity, previously untouchable talent is coming back to the market and looking to avoid the mistakes of the past by joining the scarce group of companies that are actually working.

The Longest View In The Room

Looking at the venture market today, it’s true that we’re at a moment of massive dislocation, with very limited instances of true product-market fit across the ecosystem, and diminishing end markets for the majority of B2B companies. However, we are simultaneously riding a wave of foundational innovation that is dramatically changing the return equations for VCs and startups should they be able to weather this near-term storm.

At FirstMark, one of our values is having the “Longest View in the Room.” It’s why the focused, high-conviction investment model hasn’t changed since my partners Rick and Amish founded the firm in 2008, at the precipice of one of the most divergent markets in history. As we ask ourselves how we recreate the success of that fund (Riot Games, Shopify, Pinterest — all Seed & Series A investments from that vehicle) at a similar moment of dislocation, we come to these key themes:

Focus: As a team, we make a small handful of early-stage investments and don’t deviate from our segments of the market. Similarly, we have a focus on the New York ecosystem and companies that can leverage our networks here (primarily, those based in Europe, Canada, and other major East Coast markets).

Community: From our private Fintech Driven series to our 20,000-person Data Driven community to our Guilds, which count over 2,000 members representing over 60% of global unicorns, communities are at the core of everything we do at FirstMark. Building enduring companies is incredibly hard, but communities of people who share expertise, freely exchange ideas, and demonstrate what “best-in-class” looks like, produce incredible outcomes.

Buying Time: While it’s generally agreed across the board that Founders should not be burning capital left and right, a critical question we hear is “To what end?” Being a sub-scale breakeven business growing below typical venture growth rates doesn’t get anyone to the outcome they’re looking for.

That’s why we’re spending our time focused on the dollars invested today vs. the dollars invested tomorrow. If the product in question is currently less refined, with skeptical buyers and inefficient go-to-market execution, then now is the time to double down on what’s working, build more into your ICP, and save the cash for a moment when the market and your product are better positioned for success.

Taking The Bull (Market) By The Horns

The 2023 venture capital landscape is full of contradictions and challenges, yet I truly believe we are on the precipice of a new era of growth, driven by compounding innovations, strategic consolidation of products and talent, and unprecedented resource efficiency when it comes to building and operating tech companies.

At FirstMark, like our portfolio companies, we are refining our approach to set ourselves up to take the bull by the horns (so to speak). We are staying focused on our core sectors, building deep relationships with portfolio founders and prospects, and working alongside our companies to make sure they are well-positioned through any macro in the years ahead.

We see so much to be excited about in the ecosystem, particularly here in our hometown of New York, which continues to grow and thrive, proving our long-held belief that this is the best city in the world for Founders to build the next generation of iconic companies.

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We recently raised $1.1 Billion to invest in new tech companies shaping the future. If you’re a Founder and this article resonated with you, we would love for you to get in touch.

To do so, please email me at adam@firstmark.com