Three lessons from recent VC activity trends

The dealmaking activities of VC firms reveal a lot about the industry. That’s what we learn each year when my company runs an analysis of the behaviors of global VCs across their communications, network growth and deal volume. It gets even more interesting when we compare the global VC dataset to a subset of the "top 20" firms, as defined by Dealroom in their global rankings.

Based on this data, venture capital continues to be in a state of cautious optimism. Total venture funding is no longer a falling knife, but it also hasn’t rebounded. Both communication volume and network growth are on par with where they were a year ago, and only top firms saw a significant spike in deal volume (up 69% in Q4 2023).

The data tells us that we’re in a stable but cautious and highly competitive environment. Most investors are maintaining their higher bar for quality companies, which means there’s a large backlog of capital from the ZIRP (zero interest rate policy) era chasing not enough good deals.

It’s a case of quality over quantity with both network growth and network engagement, and funds are being deployed slowly and intentionally. Here are a few lessons in today's environment:

1. The gap has widened (and that’s normal)

Dealmaking activity data shows that top firms had more than 50% higher deal flow than all firms throughout the past year.

Generally, in a tougher market like the one we are in right now, the gap between the top firms and the rest of the VC market widens. We know that top firms have a disproportionately easier time fundraising from limited partners (LPs). With a bigger capital base, they need to deploy it into more deals.

Top firms are also commonly the ones already invested in the top companies (which are also the ones in the highest demand). Many investors over the past two years have turned their attention to their existing portfolio companies and doubled down on their high-performers.

Top firms are in the best position to do this because they have the best portfolio companies—and this is reflected in their consistently higher engagement, sending and receiving as many as 30% more emails than all firms in Q4 2023.

2. There is a 'tale of two cities'

There’s little chance that rising or emerging investors are going to beat—or become the next—Tier 1 firms by copying their strategies. Being a top firm affords a very different set of assumptions and circumstances that affect how they play the game of private capital—a very different game from the rest of the industry.

For example, in the current fundraising landscape, a “flight to quality” has given existing top firms greater access to LP capital than others (check out my previous article for advice on navigating today’s challenging fundraising landscape). On the whole, they command more extensive and deeper networks to source high-caliber deals. Their brands attract greater inbound deal flow that may lessen the need for investing in outbound sourcing.

3. Differentiate your firm with data, network, and focus

The path to a competitive edge for most investors will likely not be to copy the biggest firms, but to forge their own path. Think deeply about a specific data-driven sourcing strategy that lets you see every relevant opportunity the moment it matches your fund’s thesis. There are many good datasets and tools available today.

Invest time and effort to build a unique network that you can source great deals from. Invest in CRM automation to take manual data entry out of maintaining a growing network, and relationship intelligence to monitor relationship strengths and uncover warm introduction opportunities.

Finally, don’t underestimate the importance of intentional focus. Large, multi-fund firms have the scale to widen their potential pool of opportunities, but smaller firms simply do not. Rather than aiming to be decently good at everything, home in on a niche and build a unique brand and network within that niche.

Is there a reset to come?

Looking at data through the first quarter of this year, it’s not clear whether or not the remainder of 2024 will be very different from what we saw in 2023. While top firms added more deals at the end of last year, the figure in Q1 2024 returned to the 2023 norm. Across all firms, numbers have stayed consistently low since the start of 2022.

If even the most prestigious firms aren’t able to maintain an increase in deal flow, this suggests that a broader rebound is not yet around the corner.

AI was the exception that bucked the trend of investors moving away from risky bets. Over the past year, many AI companies were funded at high valuation multiples, but without the revenue progress yet to defend those valuations. The vast majority of AI revenue remains captured by a small handful of companies, and very few application businesses have achieved significant scale. This may signal an impending and painful reset for the current AI bubble, not unlike the one we saw across tech as a whole in 2022.

Nonetheless, for now, firms would be wise to focus on growing a network in their niche and nurturing relationships to more effectively source deals in a competitive, ever-changing market.

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