Things I Think I Think - Q1 2024
The frost of winter is finally thawing and spring is upon us. Will the tech market begin to open up like early spring flowers?
In homage to sports columnist Peter King, who announced his retirement last month, here are 5 Things I Think I Think - Q1 2024 Edition:
1. Canadian Fundraising is Springing Back to Life
In my Q4 2023 thoughts, I observed that Canadian founders had largely come to terms with the shift in market conditions and predicted that we would see the Canadian fundraising market return in the first half of 2024.
If Q1 is any indication, we’re well on our way.
At Panache, we saw the largest number of companies presented to our investment committee in a single quarter since 2022 (this a key step in our investment process: when a partner shares a prospective investment with the entire Panache team).
As with any good Canadian winter, the level of activity was relatively slow until the end — the bulk of fundraising activity in Q1 took place towards the end of the quarter. January was a slow month across the country. By mid-February, early-stage fundraising activity had started to pick up. By the time spring was within sight, the level of activity had increased dramatically — March 2024 was easily busier than any single month we had observed since 2022.
That said, the resurgence in fundraising activity has not been equal across the country. Toronto-Waterloo experienced by far the most significant pickup, with the majority of early-stage deals in Canada taking place there. Vancouver and Montreal also saw an increase in fundraising activity, but not nearly to the extent that Toronto-Waterloo did. At this point, I expect their recoveries to lag Toronto-Waterloo by a quarter or two. The rest of Canada remains relatively nascent — while there certainly many companies in the Prairies and Atlantic Canada that kicked off fundraising processes in Q1, the uptick in those regions was not nearly as prominent as in the rest of the country.
Overall, the increase in domestic fundraising activity is a strong signal for the Canadian tech sector and bodes well for a strong Q2 across the country. From my previous quarterly update:
Assuming that the level of geopolitical conflict remains relatively contained, I would expect a strong (but not mind-blowing) Q1 in the Canadian private markets, followed by a notable uptick in Q2 as we head into the summer.
2. Series A is Still Glacial
While early-stage funding is rebounding around the world, Series A activity remains frozen solid (outside a handful of notably hot sectors). Two things appear to be happening:
Funds that specialize in Series A investments are being extremely cautious coming back to market, with many still remaining on the sidelines.
At the same time, multi-stage funds that leverage Series A investments as an entry point are reducing their rate of new investments at Series A in favor of doubling down on their winners at Series B and C.
I’ve spoken with dozens of Pre-Seed and Seed VCs in the past month and almost everyone is seeing the impacts of these dynamics on their portfolio companies:
Strong companies that previously raised Seed and/or Series A funding from multi-stage funds are increasingly fielding preemptive term sheets from inside investors for Series B and C rounds
Many companies that did not previously raise from multi-stage funds are struggling to generate momentum for Series A and later rounds
While most Series B and later companies had prepared themselves for a difficult 2024, many companies that had planned to raise their Series A funding in Q1/Q2 2024 are instead having to look at ways to extend their runway in order to delay fundraising into the back half of the year.
The longer-term risk here is that if the Series A freeze continues beyond the summer, it will start to propagate back to earlier stages — as Seed funds are forced to bridge more companies in their portfolios. I personally don’t expect that to happen — especially if both the early-stage and Series B+ markets continue to accelerate — but companies that are planning to raise Series A funding anytime in 2024 would be well advised to consider backup plans, just in case.
Note: Within the context of the dynamics described above, the eagerness of multi-stage funds to preempt rounds in their portfolio winners is unfortunately leading to bad behavior on the part of some VCs. I know of multiple companies who had existing investors issue preemptive term sheets, signed those terms sheets (thus delaying a full-blown fundraising process), only to have those investors renege on their commitment.
Let’s be clear here: absent the discovery of something materially negative during diligence, pulling a signed term sheet is already amongst the worst behaviors a VC can do. Pulling a signed term sheet from a company that you’re already an investor in is completely, absolutely, utterly inexcusable.
3. The Great Shutdown is Underway
In my Q3 2023 update, I predicted that we would see a lot of startups who raised their last round of funding during the ZIRP heyday of 2020-2021 but failed to achieve product-market fit close their doors. Q4 saw the beginning of that prolonged period of startup closures, a movement that accelerated in the first quarter of 2024.
But there’s a glimmer of light amidst the darkness of this incredibly difficult time for many founders: a significant number of failed startups are being acquihired.
For founders who started off with billion dollar dreams, the idea of an acquihire can be a difficult pill to swallow. But compared to shutting down the company completely, an acquihire can potentially be very lucrative for both founders and employees.
The reason this development is somewhat surprising is that, last year, the acquihire market for early-stage startups was ice cold. Going into 2024, the general consensus was that acquihires would remain few and far between. Large tech companies were continuing to shed headcount while the overall hiring market’s pendulum was clearly swinging back towards employers. As a result, most smart people (including yours truly) predicted that there would be little-to-no demand for failed startups.
It turns out that there remains a significant number of large and growing tech companies that are thriving and continue to place a premium on top performers — and top-performing teams. These outcomes won’t have a material impact on investors, but if this trend continues, we’ll see fewer outright shutdowns and less resulting doom-and-gloom across the tech sector.
4. AI Sliding Into the Trough of Disillusionment
Last quarter, I noted that we were entering a period of calm before the AI storm. We’re now well on our way into the AI trough of disillusionment.
Need proof? Think about how quickly the discourse around any new AI release flips from “this is so cool!” to “look at all the things that are broken”. Need more proof? A lot of generative AI startups that were funded in late-2022 / early-2023 on the back of unprecedented hype are quietly closing their doors.
“But Chris,” you say, “I keep hearing about generative AI startups that are raising massive Seed and Series A rounds at nonsensical valuations. How can we be headed towards the trough of disillusionment if there’s still so much hype around AI companies?”
One fascinating side-effect of the AI industry moving so quickly is that a visible split has developed in terms of the perception of where it is on the hype cycle depending on your vantage point. For early-stage investors like myself, it’s clear that we’re past peak hype and are already seeing many of the early generative AI startups wash out. In contrast, many later-stage investors are currently swimming in hype (just last week, Gary Survis of Insight Partners — a well-know later stage VC fund — shared his view that the generative AI market is currently at peak hype).
Regardless of vantage point, we’re barreling towards the part of the cycle where it’s crystal clear that a lot of the early hype was overblown. At the same time, there are an incredible number of well-funded companies that are quietly working with customers, refining their products and value propositions, and preparing their go-to-market strategies.
In the short term, expect the punditry about how overblown the hype of AI is to get really, really loud. But the real value is coming.
5. I Left My Wallet in El Segundo
While the hype around generative AI is starting to quiet, the noise around hard tech is reaching Stanley Cup final decibel levels. And El Segundo, California is ground zero.
Today, we’re seeing renewed interest in hard tech on a number of fronts:
Global conflicts shining a spotlight on defense tech
A reversal of globalization driving interest in supply chain and energy technologies
A new golden era of space accelerating research into communications, manufacturing and transportation technologies
A growing focus on climate change accelerating research into climate and sustainability technologies
A few weeks ago, I wrote about this emerging hard tech renaissance and the reasons why Canada risks missing out. One aspect I didn’t dig into in that post — but which I expect to have a significant impact on where the winners in these fields will ultimately emerge — is the growing “American dynamism” movement.
The term American dynamism entered U.S. tech vernacular as the result of a 2022 essay authored by a16z General Partner Katherine Boyle (there is now an entire section of a16z’s website dedicated to the theme). The essay served as a siren’s call to builders who not only wanted to focus on hard tech, but wanted to advance the national interests of the United States.
And many across the country have answered the call.
There is an incredible amount that one could unpack about this growing movement and its emergence in a period of increasing political and cultural conflict both within the U.S. and internationally. From a purely economic standpoint, I suspect that we may look back at this period as a key inflection point in the resurgence of manufacturing and productivity in the United States. If only a fraction of the companies that are being built in America today around hard tech themes reach their potential, the economic impact will be absolutely massive.
Founders and investors around the world — even those who don’t fancy themselves in “hard tech” — should pay close attention to what’s happening in the U.S. right now. Never underestimate the multiplier that deeply felt nationalism can be on the drive and velocity of already highly-motivated founders. That, plus massive amounts of funding and government support.