As 2024 approaches, the tech industry is still feeling the bruises of two tumultuous years that saw investment dramatically pull back. However, we detect cautious optimism that actors of the Private and Public markets have turned a corner. But for any upswing to really gather momentum, there are still a few obstacles to confront in the coming months.
So, let’s take the pulse of where we see the industry today, and what challenges it must face in the new year.
Looking at private markets, and specifically Venture Capital and Private Equity, recent weeks have become quite busy in terms of deal flow. While that remains anecdotal for the moment at late-stage/growth, there is growing confidence among investors about an upturn in VC activity in the coming year. At the other spectrum of the Private Markets, tech buyouts have made a come-back with major deals including Energy Exemplar, Rover, Sogelink or Civica all announced recently.
So what should we expect for 2024?
At late-stage/growth, investors have shifted within the year from a focus on path to profitability — sometimes at the costly expense of growth — to “efficient” high-growth. The nuance is important: EV/Revenue multiples of high-growth software companies for example now reflect a higher correlation between EV and high-growth of top line sales vs EV and Rule of 40 (and hence profitability). A strong premium is granted to those companies that combine high-growth and a free cash-flow margin of 15% +. Of course the recent funding spree in 2020–2021 and subsequent crash in valuations in 2022–2023 have put a premium on financial discipline and building a path to profitability, but high-growth (an efficient one) remains the most critical valuation lever.
However, too many VCs and PE managers have still not fully dealt with the reality of their recent past. Late-stage investors and entrepreneurs continue to delay a decision about marking down companies in their portfolio by avoiding any deals (i.e., funding or M&A) that might force them to book a sizable loss or write-down.
It’s a false hope to believe that most of these companies will grow into their over-inflated valuations given the widespread deceleration of growth. By avoiding the inevitable, the tech sector remains in limbo because part of its investors are effectively blocking the deals that would help the sector move forward. One of the most critical question marks for 2024 is how long it takes for investors to acknowledge that something has changed and that valuations need to reflect reality. And how this is translated in terms of preference stack from a legal perspective.
In 2024, many investors will finally take those losses. And hopefully, the mistakes of the past will not be repeated in the pre-IPO investment wave.
As investment recovers, PE investors will return. But there will a flight towards high-quality assets which will have the right financial metrics across business services and software. This has been evidenced by the recent deals mentioned above with valuations in line (or higher) than deal expectations.
We see investment decisions in 2024 being shaped by three macro trends:
· Macro-Economy: Investors will be watching the decisions made by central banks regarding interest rates and how they are influenced by inflation and unemployment.
· Geopolitics: There is heightened awareness of geopolitical risks and the impact of global conflicts. Investors are increasingly wary, leading to a decreased interest in China and a heightened focus on Europe and Latin America.
· GenAI: This has become a major theme, and everyone must respond to it strategically. We’ve been tracking the rise of GenAI closely and you can expect to hear much more from us on this topic in 2024 (and a bit more below!).
These forces won’t have as much impact on early-stage investments, which are more insulated because investors are looking at a longer horizon for returns. But for any company scaling up after a Series A, these factors must be monitored closely by investors and founders.
In the coming year, there are three important sectors where investors should remain focused.
First, as noted above, AI will dominate in 2024 as the most promising innovation frontier, led by GenAI. We’ll see this move beyond hype into real use cases where revenue is actually delivered.
We expect that financing of the GenAI tech stack may be driven by Non Traditional Investors (i.e, asset managers) moving more into Deep Tech. This will include funding of Foundational Models which are massively expensive and will need the deep pockets of late-stage, growth, and private equity funds to develop. Harnessing this potential will require transformation of the tech stack, which also creates substantial impact as well as costs and opportunities.
The second sector is SaaS, largely due to the first sector. This GenAI effect won’t just be felt by AI companies. It will ripple across almost the entire investment portfolio, with a SaaS stack being especially ripe for transformation by GenAI. Basically, GenAI will allow these platforms to do much more and create greater value for users, for example in areas such as HRTech or Restaurant Tech. How this will translate into pricing is a question yet to be resolved.
We’re highlighting this separately because SaaS remains such a core target for venture capital money as well as growth investors and private equity. While GenAI is getting a lot of investment attention, companies in other sectors that are being transformed by GenAI are attracting a great deal of interest from investors and as possible buyout candidates.
Finally, Climate Tech is going to remain a major investment thesis in the coming year with real applications and revenue streams emerging. Private Equity investors will largely enter the arena. As Ethereum co-founder Vitalik Buterin recently noted, there is tremendous momentum behind segments like solar power and batteries which are becoming much more robust from a technical standpoint and much more rationale from a financial perspective. They are emblematic of the way engineers and entrepreneurs, motivated by a desire to do good and supported by government policies, are addressing one of the most important existential challenges facing humanity.
Key Considerations For 2024
Underpinning these investment decisions in the coming year will be three important frameworks for evaluating High-growth and Disruptive assets.
Growth, Growth, Growth: Understanding the duration and magnitude of growth of a tech company is critical when it comes to building a conviction on a high-growth tech asset. As growth becomes harder because of external factors and because of restricted funding (in the case of start-ups), those companies that are able to pursue their path to high-growth will trade at a premium. Of course growth has always been critical, but in our view it will surpass EBITDA margin when it comes to putting a price on a high-growth tech asset in the buyout space.
This is true across software and other parts of the tech world such as marketplaces and e-commerce. As investors do their analysis, they want to have a very strong conviction on the “quality” of the growth to ensure that growth drivers (both on the existing customer base and for new customers) are well functioning.
Efficiency: The focus on efficiency that began in 2023 will extend into 2024. Startups need to combine growth and efficiency in a world where limited resources and limited capital combine with interest rates to make growth much harder to come by. In the case of software, measures of retention (both gross and net), CAC efficiency and ability to grow within the existing customer base will be closely looked at.
Governance: The recent OpenAI drama has driven home the need to carefully consider the governance of a company. Though it may appear that little changed with the departure and return of the CEO, the controversy led OpenAI to add Microsoft to its board as a nonvoting member. The seat will give one of the generative AI company’s biggest investors a bird’s-eye view into its operations.
While the question of governance is not necessarily new, it will see greater emphasis going forward as investors consider the valuation of a company. One of the biggest surprises about controversies like OpenAI or SBX is that so many investors were surprised by the details of governance. They didn’t seem to fully understand the decision-making structures of companies into which they had poured millions of dollars, and how that governance could play a role in safeguarding against weaknesses and determining whether they had a voice (or did not have one) when problems arose.
While no one can fully predict the future, they can take reasonable steps to minimize risk and associated surprises. So governance will get greater emphasis during due diligence. Because if there is one thing investors hate almost as much as taking losses, it’s being surprised.