In conversation with leading early-stage VCs

Last month, we hosted a luncheon with f7 Ventures, an early-stage, San Francisco-based venture capital fund led by two former Facebook executives. The team also has a Canadian connection, with Co-Founder and General Partner Joanna Lee Shevelenko originally hailing from Toronto. This event was part of our ongoing efforts to provide investors with expert perspectives on venture capital, which includes interviews, guest contributions, and roundtables with some of the leading VCs around the world, including Climate Innovation Capital, Sierra Ventures, f7 Ventures, Decibel VC, WestWave Capital, and Information Venture Partners, among many others. Check them out here

We’re also pleased to share an update on venture capital and related activity during the third quarter. Starting with the public markets, mixed macroeconomic data combined with the prospect that sticky inflation will push out anticipated rate cuts continued to weigh on public valuations, which in turn inform private valuations. While the Federal Reserve’s latest guidance suggests three quarter-point cuts next year, that still implies weighted average interest rates in the 5% range next year.

After a strong Q2, the technology sector gave back some of its gains with the Nasdaq 100 falling 3.2% and the S&P Information Technology Sector Index retreating by 5.6%. Despite weakness in the quarter, the technology sector continued to outperform year to date with the Nasdaq 100 up 35.5% vs 1.1% for the Dow Jones Industrial Average. Of course, a great deal of that outperformance has been driven by the Magnificent 7 — Nvidia, Meta, Tesla, Amazon, Google, Microsoft, and Apple — whose total return is almost 90% year-to-date.

Meanwhile, private markets remained cautious in Q3, with deal count and deal values remaining stable but still meaningfully short of 2020 and 2021 levels. With many venture capital-backed companies needing to refuel, we expect the pace of deal-making to pick up during the first half of 2024. We also expect to see more back-end economics in loans with companies needing to get more creative in funding their next rounds since we do not expect a material change in the valuation environment. In this regard, the significant dry powder on hand in venture capital and venture debt funds will help propel accelerated capital deployments. Scroll down to keep reading.

Q3 technology sector snapshot

Will Hutchins, Managing Director

Uncertainty weighed on public markets in Q3 as investors continued to face an unclear macroeconomic picture and the prospect that sticky inflation will push out anticipated rate cuts. After a strong Q2, the technology sector gave back some of its gains with the Nasdaq 100 falling 3.2% and the S&P Information Technology Sector Index retreating by 5.6%. Despite weakness in the quarter, the technology sector continued to outperform year-to-date with the Nasdaq 100 up 35.5% vs 1.1% for the Dow Jones Industrial Average. 

As has been the case all year, benchmark performance has been driven in large part by the outperformance of the Magnificent 7 — Nvidia, Meta, Tesla, Amazon, Google, Microsoft, and Apple — whose total return is almost 90% year-to-date. The impact can be seen in the outperformance of the cap-weighted benchmarks vs. equal-weight indexes.

Source: Nasdaq

Profitable growth remained the focus through Q3, which was reflected in steadily improving EBITDA margins as management teams continued to trim discretionary spend and preserve cash. While valuations remain compressed across the sector, those companies that are able to successfully balance growth and profitability continue to enjoy a premium from investors. 

IPO activity for technology companies remained muted in Q3. While investors cheered the IPOs of Arm, Instacart, and Klaviyo in September, the companies’ performance since going public has been mixed. Looking ahead, investors will be watching carefully to see if markets remain supportive of the backlog of expected IPOs from companies like Stripe and Databricks. With lower investor appetite for later-stage deals, some companies seeking liquidity may be pushed to go public and face the risk of not being able to achieve the valuations they received on their last private rounds in 2021 and 2022.

Source: Pitchbook

Meanwhile, private markets remained cautious in Q3, with deal count and deal values remaining stable and tracking in line with projections but still meaningfully short of 2020 and 2021 levels. With many venture capital-backed companies needing to refuel, we expect the pace of deal-making will pick up during the first half of 2024. We also expect to see more back-end economics in loans with companies needing to get more creative in funding their next rounds since valuations will remain challenging.
 

Source: Pitchbook

In this regard, the significant dry powder on hand in venture capital and venture debt funds will help propel accelerated capital deployments. And, for those seeking to exit instead, the software M&A market continues to be very active. According to estimates by Software Equity Group, a boutique software M&A advisor, deal count in the category this year should be around 3,500 deals, only slightly lower than the record 3,700 deals last year.

VC perspectives

Espresso has a broad network of venture capital partners that spans the United States, Canada, and Europe. Below we share the perspectives of some of the leading VCs in that network around a range of important topics facing the industry.

Climate Innovation Capital
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Nelson Switzer
Co-Founder and Managing Partner, Climate Innovation Capital

Estimates from the UN and McKinsey put getting to net-zero carbon emissions at between a $125 trillion and a $250 trillion economic opportunity.

f7 Ventures
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Kelly Graziadei
Co-Founder and General Partner, f7 Ventures

We’re working to change the founder and funder archetypes. Just 4% of VC firms are led by women and only 2% of VC funding goes to female founders.

Sierra Ventures
Vignesh Ravikumar
Vignesh Ravikumar
Partner, Sierra Ventures

Companies need to look and act as generative AI native as possible. It shouldn’t appear to be an afterthought.

Decibel VC
Sudip Chakrabarti
Sudip Chakrabarti
Partner, Decibel VC

If you look back over the past 20 years, there’s been a platform shift every decade. Large language models feel like that shift for the 2020s.

Information Venture Partners
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Dave Unsworth
Co-founder and General Partner, Information Venture Partners

As the world transitions to Web3 and open banking, huge amounts of information will leave secure data stores inside trusted brands and get pushed out into the ether and into the hands of individuals… [that] raises a lot of interesting questions.

Westwave Capital
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Rohan Puranik
Partner, Westwave Capital

The fact that both sophisticated AI and ML software models and tooling and equally sophisticated hardware are now widely available means that companies can build incredibly complex machinery right off the bat.

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Climate Innovation Capital
f7 Ventures
Sierra Ventures
Decibel VC
Information Venture Partners
Westwave Capital
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