Venture Capital 2024: Should Changing Market Conditions Influence VCs’ Decision-making?

By Nicolas Barthalon, Principal at Ventech VC

Lenin’s insightful words, “There are decades where nothing happens; and there are weeks where decades happen,” resonate well with today’s investment climate.

Yet, VCs, like every year, share their predictions (#value-add) independently from what happens in the world outside of the tech bubble. For VCs traditional standards: team, technology, traction TAM (Total Adressable Market) and market growth are the only criteria that matter for VCs, right? However, the speed of market change suggests otherwise. That is why we lean towards a more careful appreciation of other factors that may help us, alongside entrepreneurs, to catch the next big wave.

How much weight should VCs give to changing market conditions in decision-making?

While technological disruptions, such as Risc-V and LLMs, and investment teams are at the heart of each new investment we make, we need to pay more attention to new market conditions. These factors range from evolving regulatory landscapes to macroeconomic shifts, each carrying its weight in the intricate balance of investment strategy.

Investing in 2024 — Three pre…dominant factors

Factor 1: Regulations

Here, we face a double-edged sword. On one side, regulation gives zero market risk and a high willingness to pay to comply, offering a secure investment environment. However, this comes with the downside of a potentially narrow value proposition, limited to commoditized compliance, thus reducing the odds of becoming an innovative category-defining company.

Factor 2: Political focus — defense

That the defense industry will replace the AI hype may be a steep thesis. But the fact is that defense technologies are currently in demand and are likely to remain so in the future. The topic is as important as it is controversial. So-called dual-use technologies are therefore particularly in demand. These are products that can be used in a variety of ways, defense being only one of them.

The advantages are clear: there are budgets in the defense industry that guarantee great revenue potential. Especially when we consider that, on the one hand, crisis follows crisis and, on the other, the current inventory of European countries is in need of an update. In 2023, Germany will have 50 billion euros in its defense budget. This is set to increase by 1.7 billion euros next year. The EU’s current financial framework includes 14.9 billion euros for security and defense.

On the other hand, the exit opportunities for companies in the defense industry are severely limited — as they often have a unique buyer and can hardly be sold beyond the borders of their either national or regional geopolitical interests. For example, the European Chips Act is a testament to this exit doctrine.

Factor 3: Macroeconomic factors like interest rates

The great interest in defense technologies is the result of world-shaking events. These are hardly predictable or changeable and often have an impact on almost every industry. The 2020 pandemic and the war in Ukraine have been associated with higher inflation. To cope with these increases and try to mark the end of cheap money, several interest rate hikes have been orchestrated.

The recent interest rate fluctuations reshuffle the cards for many VC-backed companies. That may even prompt VCs to look for acyclical investment opportunities or at least look out for those that could potentially benefit from new market conditions, for instance in real estate. (See Ventech 2024s ’First Investment: einwert — Real Estate Valuations: Gone Are the Days of Manual Appraisal.)

While different funding environments call for different equity stories & funding tactics, both investors and entrepreneurs should be aware of paradigm changes in the financial markets.

Unsolicited advice for founders amidst changing market conditions

So how can founders sort out the optimal business strategy to adapt to future changes? It’s tempting to look back and aspire to learn from the experience. Since “No man ever steps in the same river twice.”, changing market conditions also require a pair of fresh eyes to walk through the valley of the shadow of product-market-fit (aka VCs’ paradise).

1. Make up your mind whether certain changes are temporary or here to stay, and define how they impact your equity story

One case in point would be the remote working policies post-Covid. We now see a big trend of companies calling back their employees in the office for the entire working week. This may seem harsh for some employees who have grown accustomed to zero-commuting. Yet, for startups, there’s a vital NEED to truly onboard team members, make quick decisions and guarantee fluid interactions. Tech tools are not everything for everyone… Well, the call is yours to make.

2. Do your own risk management

Investors analyze the risks associated with companies they want to invest in, but so should entrepreneurs! Indeed, given that revenue quality now trumps growth at all costs, an understanding of their counterparty risks is vital at the early stage of a startup, for its customers, banks, sales partners and of course investors.

3. Making the most out of governmental regulations & understand the legal framework

Who said that the US innovates, China copies and the EU only regulates?

What sounds like a restrictive corset for European entrepreneurs doesn’t have to be restrictive. New business opportunities can also rise from regulations and pave the way for new market categories.

Let’s take the example of Prewave — not so humble brag disclaimer: our very first remote-first lockdown investment. Prewave provides full supply chain transparency, thus meeting obligations under the Supply Chain Act Germany and the CS3D at EU level. In other words, they remove a massive weight off their customers’ shoulders: have you ever tried checking safety work standards for thousands of suppliers at once?

Regulations can perhaps even have an inspirational effect, as they provide a breeding ground for innovation. The newly approved European law — DMA (Digital Marketing Acts) — can also be an opportunity engine for startups and SMEs.

In addition to the regulations that are already in force and have an impact on your own business, entrepreneurs should also look ahead. What changes of power and elections are coming up? Which country currently holds the presidency at the European level?

4. Cultivate relationships with the public sector

Not every young company can afford to lobby. Apart from the working hours, lobbying is not a sprint, but a marathon. Building relationships with public decision-makers is ever important in order to be close to current discourses.

5. Building relationships with investors at an early stage — even before the financing round!

Entrepreneurs should want to get to know their investors well. The aim should always be to find a long-term partner for your venture rather than just a short-term gap-filler.

Crystal ball vs leap of faith

It is understandable that founders only want to focus on what they can control. However, well-explored guesses by founders about “new” dimensions such as geopolitics, regulations or macroeconomic events are more than welcomed by investors. Quite often, an entrepreneur’s unique interpretation of market changes & how to benefit from them is what ultimately convinces us to invest (& end up being the basis for publicly shared predictions…).

Which new market condition caught your attention lately? Leave a comment below!