This week on the startup to scaleup journey:

• AI startups defy venture funding decline
• Founders embrace a back-to-basics mindset

AI startups defy venture funding decline

Global venture funding in 2Q23 fell 18% quarter over quarter to $65B, according to Crunchbase. That’s down 49% compared to the second quarter of 2022, when startup investors spent $127B. Looking at the first half of 2023, investment is down by a similar amount. In 1H23, global funding totalled $144B, marking a 51% decline from the $293B invested in 1H22. Since 3Q22, each quarter’s global funding total has dropped by more than 45% year over year. Global deal volume is also down significantly, by 37% year over year. It should be noted that these are very early numbers for Q2 which are expected to increase after full reporting in the coming months. Even so, the data shows that around 6,000 startups raised funding this past quarter, compared to more than 9,500 for the same time period a year ago. Crunchbase data shows that we are now four to five quarters into the current funding decline. As the downturn really took hold in 3Q22 these year on year drops still look alarming but from now on these reductions will level out as we adjust to a new normal. For example, if we compare the second half of 2022 with the first half of 2023 we only see a 10% decline in global investment.

Drilling down further into the Q2 global numbers, there are some key variances by stage: Late-stage deals totalled $31B, down 54% compared to $68B a year ago. This was the lowest quarter on record since 2018. Deal numbers were down 40% reflecting how average deal sizes at Series C and above have tumbled. Early-stage (typically Series A and B) funding reached $27B in 2Q23, down 45% from the $48 billion invested in 2Q22. Deal counts were down 35%. Seed-stage startups raised $6.8B in 2Q23, down 39% from the $11.2B invested a year earlier for the same time period. This is the lowest quarter of seed funding to startups since the peak in 2021. This early data shows that 1,500 companies raised a seed round of $1M or more in 2Q (from a total cohort of just over 4,100 companies that closed a seed round) compared to around 2,500 for the same time period a year ago. It is now clear that companies are being stuck at Seed stage for longer as A rounds become rarer due to elevated criteria. In May, Crunchbase reported that the median time between a $1 million-plus Seed and a Series A has stretched all the way out to 25 months. From our ring-side seat as advisor to dozens of startups, we are seeing an increasing incidence of multiple rounds of funding through Seed stage, with the bar for last round (aka the 'pre-A round') reminiscent of a 2021 Series A in many sectors.

Bucking the trend, however, are AI startups that have seemingly defied the overall decline in VC funding of the past 18 months, collectively raising $15.5B this year according to PitchBook data. Even when you exclude OpenAI's $10B round, the sector's VC funding in 2023 has surpassed last year's total and is well over halfway to 2021's peak of $9.1B. [Note that the definition of 'AI startup' varies considerably depending on the source. Crunchbase takes the most liberal view, attributing $25B of deals to this vertical in 1H23, which would represent a whopping 18% of overall global funding.] On top of that, AI deal pace has remained steady and median post-money valuation is up 109.8% from last year. While VCs have become more cautious with the downturn, the eagerness of some investors to plough capital into very early stage AI startups suggests that some of the exuberance of 2021 remains. There's no doubt that without the AI buzz kicked off by the launch of OpenAI’s ChatGPT in November, venture funding so far in 2023 would have been even lower. Some VCs and high profile CVCs like Salesforce Ventures have even launched dedicated AI funds in recent months. As Pitchbook comments: "While one could argue the scale of AI opportunity justifies the hype, this recent investment activity suggests that a sort of herd mentality has taken hold." Expect this to build over coming quarters as a deluge of new startups targets the adoption of AI in the enterprise.

Founders embrace a back-to-basics mindset

Founders planning to raise capital soon might be forgiven for feeling anxious given market conditions. As reported by Dealroom, total investment volumes in Europe look set to reach $50B+ for 2023, based on 1H activity. This would represent a 50% drop compared to the record highs of 2021 and around 38% down on 2022. In private markets, valuations have returned to between 5 and 10 year averages, with Seed stage displaying the most resilience. And, inevitably, down rounds are beginning to appear in the data. 1 in 5 venture fundraises in Q1 this year were down rounds, compared to barely 1 in 20 a year ago. But if Europe hits the anticipated $50B figure in 2023, this will still be roughly 35-40% ahead of what we saw in 2020 and 2019. Even in a market downturn, Europe is on track to have its third largest year in terms of funding raised. Great companies are still raising capital, great teams are still being built, and great products are still changing industries. Founders that are winning through have embraced a back-to-basics mindset - and we can see this at first hand.

At the end of every week we undertake a series of roundup calls with the startups we are supporting. Some are in the funding preparation stage and some are already executing their campaigns, engaging with investors, and closing deals. What we talk about each week has shifted as markets have hardened. For those in preparation, there is greater stress-testing of the investment proposition and the underpinning financial projections. For example: Is the problem we are solving being articulated in the most compelling way? Are we creating measurable value for customers and packaging that value into a product that can be purchased and adopted in the easiest possible way? Is there a clear roadmap to the next funding round given increasing market headwinds? And for those in campaign mode: Are we targeting investors that still have cash to deploy? Is the pipeline of investors big enough given the much lower hit rate now expected? Are we tailoring our outbound approaches sufficiently to grab attention and secure that first meeting? This combination of reaching out to a longer list of targets as well as undertaking deeper research for each one really tests the resolve. But it pays off. Our own evidence confirms that founders that really go the extra mile in personalising cold approaches enjoy the highest conversion rate into meetings.

Investors consistently say that the best founders are great communicators and that the initial email sends the clearest signal. Veteran VC, Jason Lemkin, says that many top investors love getting the best cold inbound: "I only invest from inbound...every deal I've tried to go out and get I've failed. I do nothing outbound. Every warm referral doesn't work out. Nothing works out except the 'high velocity' inbound email." He adds that as a result, he often makes the emotional buying decision before he even meets the founder. In turn, founders say the first meeting had real 'resonance', often centred around a mutual understanding of the problem being addressed. But this early meeting of the minds, this chemistry, is how it used to be. It's really nothing new - unless you were a founder raising for the first time at 'the peak'. The great con of this period was that easy money was the reality. But the true reality was that sound business and capital-raising practices had only been briefly suspended. As VC, Gil Dibner, says in his latest blog post: "We are - I think - also undergoing a mass education event. We are all relearning through our own painful experience the hard-won lessons of previous generations of startups."

Happy reading!