Why Venture Investors Prefer Early Stage To Later Stage Startups So Far In 2023

Early stage investing has taken precedence over later stage companies because of their lower valuations and relatively limited  exit strategies. 

Given the opportunity early stage companies have to grow past the current downturn, they appear to many investors to be the better option at present. JL 

Louis Lehot and Lyman report in Foley Ignite:

Startups at the angel and seed stages are leading the way in 2023, with median seed valuations growing by 16.7% to $10.5 million. This is the highest annual value ever recorded by PitchBook. There continues to be a more difficult road for later-stage companies as they are faced with lower valuations and a lack of exit options, mainly because of a freeze in IPOs. Median and average public listing valuations fell to $214.0 million and $604.0 million, respectively—their lowest points since 2016. Public exit valuation step-ups tumbled as well, falling 32% to 1.05x, offering little upside for investors who participated in the most recent funding round.

We have talked a lot about valuations over the past few months, as many startups have seen their valuations drop due to a myriad of issues on a global scale. Pitchbook has released its 2022 US VC Valuations Report, and the findings are illuminating (if unsurprising) based on all the trends we saw emerge, particularly in the year's second half.

First, they point out that despite all the global issues impacting the economy and the market, overall, the valuations of US-based startups remained strong, particularly for some specific segments. It should come as no surprise that startups at the angel and seed stages are leading the way, with median seed valuations growing by 16.7% to $10.5 million. This is the highest annual value ever recorded by PitchBook.

These very early-stage companies have been able to weather the storm much better than those at later stages, and it’s not just for US-based startups. We are seeing this on a global scale. In this current climate, investors are taking bets on these early-stage companies and scaling back on investments later in the startup life cycle. So, it makes sense that this would be reflected in higher valuations at the seed and angel stages.

Pitchbook does point out in the analysis of their data that while early-stage startups did maintain an overall healthy level of deal activity in 2022, Q3 and Q4 were less robust than Q1 and Q2. There was a downward trajectory from Q1 to Q4 as the market continued to soften, and the early-stage median value fell by 33.3% from the beginning of 2022 until the end of the year. 

As we have previously discussed, there continues to be a more difficult road for later-stage companies as they are faced with lower valuations and a lack of exit options, mainly because of a freeze in IPOs. Some of their key findings in this area include:

• Median and average public listing valuations fell to $214.0 million and $604.0 million, respectively—their lowest points since 2016.
• Acquisitions remained relatively resilient, with median acquisition valuations declining by just 3.5%.
• Public exit valuation step-ups tumbled as well, falling 32% to 1.05x, offering little upside for investors who participated in the most recent funding round.

These trends will likely continue at least through the first half of 2023, as economic conditions have not dramatically changed since last year. The interest on the investor side seems to be leaning towards these very early-stage companies, but they will, of course, not stay at that stage forever and will need to move on to additional rounds of funding down the road. Innovative founders need to give themselves a longer runway so they have more time for conditions to improve before their next investment round.

Meanwhile, for those raising capital in the meantime, we can share anecdotally that we are seeing businesses lead their pitch with how AI is integrated into their product roadmap, its impact on AI infrastructure, and how AI accelerates their penetration of vertical markets. 

It's all about the early stage, and it's all about disruption through AI in 2023 so far.