State of venture markets in 2023

— Excerpt from Stoic VC Year in Review

Biotech was a constant in 2023.

There were a few narratives that dominated markets in 2023, none more so than the reversion to the ‘new normal’ (that might not actually be that new). There’s a good argument that the decade leading into 2022 was actually the aberration and what we’re seeing now is business-as-usual. For deep tech (DT), it’s easy to be distracted by the GLP-1 and AI hype cycles that prevailed this year. But 2023 was largely encouraging, even if hurdle rates were adjusted across the board. My high level observations below.

TL;DR

1. The ‘departure’ caused more economic damage than we thought but likely to be less pronounced for DT. The nature of development and enormous capital requirements, makes it difficult for markets to differentiate hype from real. The constant demand for these companies tends to provide added insulation against economic cycles. We do however expect the DT “zombies” to go under in the next couple quarters, but this will be a much needed market clearing mechanism.
2. 2023 may have been a great vintage for DT venture capital, but investors were hesitant. With loss of public market metrics and 2022 seared in their minds, investors were more selective than ever. Regardless, good opportunities continued to be financed.
3. Life sciences unrattled by macroenvironment. Despite rate increases and geopolitical tensions, 2023 was a good year for early stage biotech. Loss of exclusivity (LOE) period continued to drive M&A. This had positive implications for upstream R&D.

Rehashing the aberration

The Zero-interest-rate-period (ZIRP) made risk capital very accessible and we saw the height of this decade long- run of risk on in 2021. Lower cost of equity, confidence in ‘handoffs’ of capital between rounds as well as public market demand created the ideal fundraising environment — in particular for capital intensive companies. DT companies that found ways to create FOMO by selling their grand visions (whether hype or not) or showing the slightest signals of market acceptance, raised millions. Most capitalised on this and rushed the public markets by SPAC or IPO to raise cheaper.

Reality of the past 18 months

When risk off capitulated markets in 2022, these same companies weren’t able to access risk capital so easily. The implosions of well funded DT companies have certainly rattled markets but its likely the economic damage will be less severe than anticipated. Largely due to the nature of DT development and higher barriers to capital.

In 2021, investors had become complacent and less prudent with their capital. DT companies were encouraged to prioritize growth at all costs and accelerate development. But for companies taking on predominantly technical risk, growth isn’t exclusively a function of capital. DT companies have longer incubation periods and create value (initially) away from the market. Thus allowing large purchase orders or contracts to be secured with little to no revenue. Irregular and step-function like growth, therefore makes it difficult for the market to price companies that are hype and those that are real. In addition, it takes enormous amounts of capital (i.e much more expensive) to bring DT companies to market, therefore less likely that public DT is just hype alone. This dampens the effect of the economic damage, something we’re already seeing rattle low margin and highly cyclical sectors ( DTC commerce, on-demand services and micro-mobility).

Zymergen was perceived as the golden child of genetic engineering. It collapsed in 2022 after raising more than a billion and went public at a ridiculous 200x revenue. The wasn’t to do with the technology, but rather its path of financing. Softbank was far too aggressive and reckless with their capital. This encouraged Zymergen to rush product development and IPO. Synbio performance has continued to surge — this should illustrate my point.

Companies like Zymergen which raised ‘bad’ money and took short cuts imploded. Whilst the top crop of companies which extended runway and readjusted G2M, became even more resilient and efficient. A good and necessary outcome for DT at large.

At the beginning of 2023, we likely saw the bottoming out of the market. Many US public deep tech companies had taken 30–40% haircuts by this stage. By the end of 2023, the story was different. This is illustrated below.

Deep tech index across three years. Important to note NVIDIA and ASML carrying the weight of the resurgence.

The last 6 months has seen listed DT rebound significantly, skewed largely by Big tech chasing AI and NVIDIA’s unreal performance. This hype cycle has attracted capital to early-stage startups innovating not only generative AI but across the entire value chain (advanced materials, semi-conductors and cybersecurity).

In addition, the initial recalibration in public markets (excluding the aforementioned) has created a unique investor’s market. The 2022–23 trickle down to private markets brought down early-stage multiples even with sunk-cost reactions from founders. With the death of “growth at all costs” and resurgence of fundamentals, most startups lost their leverage and struggled to prove up the same valuations. Leading to the swath of ‘at’ and ‘down’ rounds throughout 2023. The uniqueness of this investor’s market is that early-stage DT valuations will take a while to reprice to current public comps. Low levels of liquidity will extend this out further. If current trends hold, this divergence may have created one of the best vintages for DT in the last decade.

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One of our key observations this year is that DT has remained largely unrattled — in contrast to its software cousins that’ve taken hits across the board. Biotech in particular has seen a resurgence at the early-stage.

Surge in median pre-money valuation in Biotech. Likely to have been influenced by Ozempic/Wegovy success.

Whilst biotech IPO’s have sunk since 2021, the current LOE period (2023–2030) has instead spurred M&A activity. Biopharma’s exposed to sizeable potential revenue attrition, have been forced to recycle their assets with new acquisitions. What I’ve observed is that quality R&D continued this year, whilst pharma companies have been moved up the market — earlier than they ever have for high value assets. Its no secret that the success of Wegovy and Ozempic has attracted even more capital to upstream R&D in similar indications. There is a reported 50–60 comparable in the pipeline currently.