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The dry powder fallacy, 50 shades of PMF & why this VC slowdown is more protracted than expected

As we’re nearing the end of the year, we can look back on an eventful 2023. We have seen a lot of activity in our portfolio, welcomed both new companies and people into the Oxx family, and we’ve proudly announced our new fund generation setting us up for an exciting period ahead. On a broader scale, several macro level events have impacted the world and our industry. Over the coming weeks, we’ll be sharing some of the team’s perspectives on the past year, key moments or insights and what we can expect in the future.

In part I, Phil, Gökçe and Mikael give us their insights with a focus on the past year, and, when applicable, put in context to previous cycles.

The Dry Powder Fallacy

Phil Edmondson-Jones, Partner

Phili Edmondson-Jones

Over the course of 2023, commentators highlighted the large value of ‘dry powder’ (committed but unallocated private capital) in the venture and growth ecosystem. Many believed that this would lead to a sudden acceleration in deal activity. Despite strong early stage VC momentum at the Seed stage (primarily gen AI and climate-tech); this hasn’t been seen at the scale-up or growth stages, bar a few exceptional cases.

Why haven't these stages seen that effect? This can be boiled down to two reasons. Firstly, the supply of dry powder being overstated, due to high rates of completed and expected internal investments (to support existing portfolio companies) and lengthening of fund deployment periods. Secondly, the demand side for capital being materially reduced, as a consequence of startups’ reducing burn and cautiously approaching fundraising in an environment of slower performance and volatile valuations.

Throughout 2024, we’re likely to see a steady re-acceleration in later stage venture activity (rather than a sudden explosion) as the macro recovers, valuations and expectations stabilise, and company performance improves. We’re feeling optimistic!

2023: A test of where companies stand on the 50 shades of Product-Market-Fit

Gökçe Ceylan, Investment Professional

Gökçe Ceylan

In 2023, a year in which layoffs, cost cuts, and zero-based budgeting have been the ubiquitous themes, perhaps counterintuitively, there was an increase in SaaS spend. Figures show that companies’ SaaS spend increased as a total (by 18% to $197b), as a share of all spend (from 12.7% to 14.1%), and per employee (by 27% from $6,220 to $7,900)*. So, if people spend more on SaaS products, does this mean it’s become easier to sell software in 2023? Not quite: on the contrary, renewals of existing contracts comprised a larger proportion of all SaaS purchases (81% in 2023 vs 70% in 2022)*; companies’ implementation of zero-based budgeting prolonged sales cycles, and there was an increase in customer acquisition cost for software providers.

The increased difficulty in selling SaaS in a market where companies overall are investing more in software solutions has meant that not all providers have benefited equally from this trend. SaaS providers have been forced to test the mission criticality of their products and where they stand on the 50 shades of Product-Market Fit: While some providers jumped in to enable companies to ‘do more with less’ amidst layoffs, fearlessly increasing prices as much as over 20%, others witnessed increased churn rates and a stall in new client acquisition. That’s why 2023 has been a year for many to go back to the drawing board to reassess the fundamentals of their businesses.

SaaS will stay not just a resilient but a thriving category. And those SaaS providers that double down on showcasing the value and ROI of their products and invest heavily in ensuring their customers not only adopt but continuously derive value from the software, will emerge stronger and more resilient in the evolving market. 2024 will continue to be a reminder that product-market-fit is a spectrum that goes beyond the initial fit, and encompasses the adaptability of a product amidst changing customer needs.

Why this venture slowdown has been more protracted than expected

Mikael Johnsson, General Partner & Co-founder

Mikael Johnsson

Seen through a broad historical lens, the past years form an interesting case compared to previous cycles. Venture funding, both for companies and into venture capital funds, has been steadily declining for the last 18 months with funding down about 60% – it is now back at 2017 levels. M&A deal activity has been hit even worse, with exit values dropping about 90% YoY back to the same levels as immediately following the global financial crisis. While the industry has expected an upswing in funding and deal activity sometime during 2023, at least over the last 6 months, this hasn’t happened.

In the wake of the global financial crisis of 2008 and 2009 central banks all lowered interest rates to stimulate growth. Thanks to globalisation they were able to maintain low interest rates to stimulate the economy without introducing a massive upward pressure on inflation. This also allowed the economy to recover and get back to healthy growth relatively quickly which in its turn led to a healthy environment for venture funding and deal activity.

However, eventually, in this zero interest rate world, yields from traditional asset classes dropped dramatically, forcing investors into riskier asset classes to generate their required returns. Ultimately this capital migration tripled the amount of money that went into venture capital as an asset class in 2022 compared to the 10 year median. With a massive oversupply of money chasing a limited amount of great companies to invest in, valuations grew by a factor of 3-4x. The quick recovery from the 2008-09 crisis caused an unsustainable situation. It took 13-14 years for reality to catch up with the combination of high economic growth and loose monetary policy, which drove a massive pent up increase in inflation and a correspondingly dramatic increase in interest rates.

This macro backdrop has sent venture funding and deal activity into a tailspin and back to 2017-2018 levels while forcing a reset in terms of growth expectations and capital efficiency for venture backed companies. There is simply no free money available to fuel the growth-at-all-costs model anymore.

So what are the key takeaways from this? The market is taking longer to adjust this time around because there is such a massive overhang from the last 15 years, particularly the 2020-2022 period of exuberance.

  1. The amount of money companies have raised has gone up significantly, so the ones that were alert and adjusted their burn rate have a longer runway before having to fundraise again

  2. Similarly, venture debt and other debt instruments have become a key product allowing companies to raise more and (theoretically) cheaper money to extend their runway

  3. Investors have invested into companies at valuation multiples that are several factors higher than current market multiples and raising external capital would force the company to take a downround and investors to mark down the value of their holding correspondingly. This is not something that is easily swallowed in a market where VC fundraising is already more challenging than ever before.

  4. Investor sentiment has changed more towards favouring profitability over growth, so many companies have cut costs to reach profitability instead of increasing growth.

Stay tuned for the next part to learn what other members of the Oxx team call out from 2023.


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