The last 18 months felt like an everyday hangover for many VC investors.The fall in public valuations first struck hard those who were not able to sell their shares in companies listed in 2021 due to lock-up; those who planned to IPO had to review their plans, and for many, they were refinanced with non-standard terms in order to maintain their valuation. Meanwhile, the last 6 months have seen a multiplication of internal refinancing to bridge early-stage companies until the next round of funding or profitability. 

The difficult adjustment of private markets

This slump has brought a day of reckoning for many. Who is to blame for the boom and bust? VCs flushed with cash who pushed founders to take more money than they reasonably needed to speed up their growth? Founders are always looking for the highest valuation possible, even if disconnected from the reality of the business? U.S. investors playing tourists and leaving as soon as the sun stopped shining? The reality is that the tech private markets are flawed. In public markets, good times lead to skyrocketing valuations, and in bad times, valuations adjust. In private tech markets, valuations don’t adjust because of the stigma attached to it and the big impact it may have on founders’ ownership and motivation. With VCs having raised big funds and still looking for the next fund returner, the scarcity of good assets with the potential of a +$5bn exit opportunity leads nevertheless to high competition and 2021-like valuations for the best-performing companies. Average-performing assets are not repriced while good quality assets are still overpriced, making it difficult for VCs to make the math work. 

Turning to real-world problems

This day of reckoning has also led investors to change their mindset as some sectors have quickly fallen out of favor. Food delivery, ecommerce, and consumer-focused businesses have shown their limits: high capital intensiveness even for asset-light platforms, difficult path to profitability, high acquisition and retention costs turning a significant portion of VC money into net profits for the gatekeepers of the Internet, Google and Facebook. 

Investors are now turning their interests to real-world problems. Companies succeeding in downturns and surviving budget cuts will be the ones solving a massive issue and driving a clear ROI for their customers, especially on sectors particularly highlighted during the Covid-19 pandemic and the Ukraine crisis for their fragility: supply chains, industrials, productivity tools are cases in point. 

At the same time, VCs remain natural optimists and bet on clear growth trends. With the clear path drawn by E.U. regulations and the Inflation Reduction Act in the U.S., VCs are pouring money into renewable energy, electric mobility, home renovation, new materials, and carbon offsetting. Over $40 billion have been invested worldwide in 2022, only a 3% decrease compared to 2021 despite market slowdowns, and 28% of the total VC investment for the same period. The decrease is mainly due to growth deals, while early-stage activities are on a positive trajectory. At Eurazeo, our investment into 1KOMMA5 was driven by the realization that the urgent need to decarbonize our economy relied on aging and subscale craftsmen struggling to hire qualified workers, and that a buy-and-build play on solar and HVAC installers was the quickest way to reach scale, make an impact, and solve the supply bottlenecks. 

However, investors remain cautious. Nobody wants to invest in a “Ukraine stock” whose top-line growth is driven by a momentary market pull. Climate tech also covers a variety of sectors with heterogeneous maturity and liquidity. The last Climate 1.0/ Cleantech boom ended in a big failure. Between 2006 to 2008, $25 billion were invested and recorded a 50% net loss (Cambridge Associates). Today’s conditions are different, but the risks have not disappeared: technology-readiness is much higher than 15 years ago, and the market appetite for sustainable solutions is now much stronger, driven by the regulatory push and consumers’ awareness of climate change. 

However one should be careful of the risk/reward ratio in capital-intensive businesses where the investment horizon can be long, and the cycle of financing is still not complete at every step of the journey. Many companies also rely too much on a potential ability to charge a “green premium” or expensive carbon credits spending to reach positive unit economics.

AI boom: are we back in 2021 ?

The launch of ChatGPT has been for AI a “Sputnik” moment. While investors had turned to a more down-to-earth mindset, the new potential offered by these tools opened to anyone has galvanized a new wave of companies. Most popular deals mainly focus on sectors with large existing datasets and quick go-to-market such as sales, customer support, productivity & operations or engineering, product and design. Despite this new space being still new and rapidly evolving, it nevertheless looks very consolidated with the usual giants Google and Microsoft heavily invested and integrating AI tools to their suite. More than ever, VCs are building their investment thesis and investing in the dark, on shaky grounds, betting on founders’ velocity and technical skills to succeed as the sector will evolve. But after a few years of investments into businesses with low technological intensity and differentiation, this new boom of AI brings a welcomed breeze of fresh air on the market.