2023 VC Predictions: Investing in Value-Driven Innovation

By Ryan Mendoza, Partner

Between rising interest rates and limited partners (LPs) gradually reducing their exposure to risky venture capital (VC) deployments, it’s no secret that VC investors ended 2022 more cautious than they were this time last year.

Despite these sentiments, at Scrum Ventures, we believe there will be many promising early-stage startups to invest in during 2023. Although LPs will likely pull back on VC investments, it’s important to put this trend into context. LPs invested heavily in VC funds over the last year, which means VCs still have plenty of cash to invest.

Increased VC Interest in Early-stage Startups

Late-stage funding will continue to decrease, and investors will be evaluating companies during seed and series rounds with very specific criteria in mind.

When deciding where to invest, VCs will be focused on finding startups that are solving large-scale challenges — in areas like sustainability, supply chain dynamics, and digital financial services. Even more importantly, VCs will need to see startups show strong fundamentals, challenging founders to provably demonstrate the return on investment their product or service has to offer.

And VCs aren’t the only ones carefully evaluating the likelihood of startup success — tech employees are as well.

The number of tech employees laid off since early 2022 continues to climb, with more than 46,000 workers laid off during the first three weeks of 2023 — adding to the 107,000 laid off last year. Amid the cascade of layoffs across the tech industry, more entrepreneurial tech employees may be reluctant to risk another layoff. As a result, some will choose to instead become founders themselves, competing for early-stage funding to start their own businesses.

Demand for Solutions with Tangible Results

As we touched on already, VCs still have plenty of capital to invest, but they’re looking for startups that meet their increasingly stringent selection criteria. Founders that have the fundamentals, product-market fit, and economical mindset that investors are looking for will still be able to raise funding, albeit with lower-priced rounds than seen between 2020 and early 2022.

Going into 2023, our team also expects to see an increased focus on solutions for mission-critical digitization and operational efficiency. To succeed in this climate, founders need to deliver solutions that deliver clear value.

Founders and Investors Are Choosing Efficiency and Productivity

Over the last 2–3 years, the market has been much more open to exploring tech capabilities. As we observed at various accelerator demo days in 2021 and 2022, investors were more than willing to consider startups still early in their research and product development. That’s no longer the case.

Potential customers — and therefore VCs — will have little appetite for exploratory efforts, especially among B2B organizations. Startups with offerings that can quickly and measurably improve operational efficiency, aligned with prioritized, mission-critical capabilities (e.g., cybersecurity, cloud optimization, automation), will have a significant advantage.

From small businesses to enterprises, business leaders are highly focused on bolstering operational efficiency and productivity.

These organizations want solutions that can enable ongoing digitization initiatives and will have a clear effect on their bottom line. Cloud optimization in particular will be important for improving costs and maintaining efficiency despite added infrastructure complexity, as more organizations deploy mission-critical systems and applications in multicloud environments.

Organizations are also looking for ways to streamline operations using automation and artificial intelligence (AI). Before implementing these solutions into their infrastructure and workflows, however, business leaders will need vendors to readily demonstrate the expected ROI, operational impact, and lifetime value of their automation or AI solution.

Artificial Intelligence Is Going Mainstream

Although investors and B2B buyers will have a more prescriptive view of which technologies are worth their time, that doesn’t mean that emerging technologies like AI won’t continue to evolve. Already, the launch of amazing new language learning models (LLMs) has ushered in a new wave of interest in generative AI.

As AI has gone “mainstream” over the past couple of years, many organizations are working hard to launch their first use cases, focusing on low-hanging fruit that is relatively easy to implement and promises reliable returns. In 2023, we’ll start to see businesses emerge with specialized use cases and defensible products that make them promising targets for VC funding.

For example, some companies are already exploring how they can embed LLMs into existing products and services as part of their front or backend operations in areas such as fintech, supply chain management, and enterprise productivity. Again, many larger tech organizations will be able to acquire promising startups at good prices, allowing them to rapidly ramp up their AI capabilities and keep pace with further advances in the space, such as deep learning based on artificial neural networks.

The more complex capabilities that these solutions can support, the more that small, mid-size, and enterprise businesses will integrate AI into important workflows, improving operational efficiency.

Notable Sectors: Supply Chain & Logistics, Climate, and Fintech

The demand for increased operational efficiency transcends industry boundaries, but this push will be especially strong in sectors that have seen significant disruption over the last few years. In particular, we’re keeping an eye on supply chain, climate, and fintech startups in 2023.

Supply Chain Disruptions Are Driving Overdue Tech Adoption

Supply chain and logistics is an antiquated industry that consistently lags behind when it comes to tech adoption. The convergence of several dynamics has caused huge issues to disrupt supply chains globally for the last three years, a problem that only promises to worsen due to looming labor shortages, overwhelming consumer demand for fast delivery, omnichannel purchasing, rising inflation, and extreme weather due to climate change.

The fallout from these factors will force tech adoption in various sectors of the industry. But although AI solutions promise to help introduce flexibility and resilience into supply chain operations, it won’t be a completely smooth transition. Transformation is needed at every link in this complicated global system — including freight, trade, long-haul trucks, and last-mile delivery.

At the same time, the recently enacted Chips Act will prompt a return to U.S.-based manufacturing, which means increased opportunities for tech adoption at regional warehouses and distribution centers.

Logistics leaders are readily piloting and adopting new technologies to create resiliency and transparency in supply chains, including data infrastructure, the Internet of Things (IoT), automation, and more. Carbon accounting in the supply chain and adopting sustainable operations are also top of mind for logistics operators and their enterprise clients.

Increasing Demand for Action on Climate Change

The clear effect of climate change on the economy and supply chains has increased interest and demand for technology that can help reduce energy consumption and carbon emissions.

VCs that have already invested in this sector are poised to realize impressive returns as more specialized sustainability products and services emerge and value chains become more established. As investors begin planning and executing their exits, there will be additional opportunities to create AI-driven solutions for:

• Carbon accounting.
• Carbon capture and removal.
• Renewable and nuclear energy.
• Sustainable materials development.
• Alternative meats and food products.
• Material supply chain management for batteries, solar cells, and storage tech.

Turning to AI and Automation to Improve Fintech Value

Today’s companies need to get paid faster and have predictability in revenue streams, which means they’re looking to use platforms that automate payments, digitize transactions and even process the data in real-time.

As companies look to take even more control of their top and bottom line, fintech users are looking for tools that offer better financial tracking, transparency, and modeling. With the simultaneous maturation of AI and automation capabilities, we expect to see more fintech solutions that use AI and LLMs to weigh the impact of user decisions and behaviors.

The fintech space may also transform VC itself. In this tougher fundraising climate, more founders will be motivated to pursue available alternatives to capital, such as equity crowdfunding, venture debt, revenue financing, and project financing. Startups developing solutions for this problem — such as embedded financing — will have a prime opportunity to showcase their capabilities.

The 2023 Startup’s Growth Roadmap

Whether they’re in climate, supply chain, fintech, or any other sectors, to be successful in 2023, startups will need to chase the same operational efficiency that their prospective customers are looking for. The innovators who survive and thrive during this period will be those who tackle large-scale problems and deliver innovative solutions with true impact.

These priorities will be difficult to balance in today’s incredibly competitive conditions, which means startups should consistently focus on three things:

1. Prioritizing product-market fit.
2. Lowering their customer acquisition cost.
3. Pursuing new distribution models.

Expect to see more companies moving away from traditional — and often expensive — digital channels like Meta (i.e., Facebook and Instagram), LinkedIn, or Google and instead using affiliate marketplaces or establishing B2B channel partnerships with set pricing. We’ve already seen this model work with benefits brokers and insurance companies, who have the ability to offer tech services to employees at client companies or work with startups to create embedded products.

The days of the growth-at-all-costs mindset have, at least temporarily, come to end. Now, startups led by savvy founders who are focused on cost-effectively creating and delivering real-world value are the ones who will be set up for success in 2023.