A few weeks ago, Ben Lerer, managing parter of Lerer Hippeau, a New York-based early-stage venture firm, set his sights on leading a young enterprise software startup's seed round. Given it has been a struggle for non-AI startups to raise capital in 2023, he did not expect much competition with other investors.
"I thought everyone's been slow to deploy and we're in this time where there's not a bunch of capital availability," said Lerer, who was not ready to share the startup's name.
But Lerer was surprised to see the startup land seven term sheets, something he and other VCs Business Insider spoke with say is emblematic of the unique venture market that was 2023 and will likely continue next year: An extreme divide between have's and have not's, with very small differences in the companies that captivate the interest of investors.
"When deals get hot, there is extreme interest," Lerer said. "But if you are on the wrong side of it, there's not a cent."
To be sure, venture funding has always been unequal with some startups raising gobs of money and many more left out in the cold. And there is a long list of once-hot companies that have gone belly up, with Bird being the latest example.
"I think people love to talk about hot deals, but I don't detect any difference from other cycles," said Roy Bahat, head of Bloomberg Beta. "It's the same as it always was."
But other VCs say they saw far more binary outcomes this year as they deployed much less capital to fewer companies, which is backed up by funding data.
Through the first three quarters of 2023, startups raised $221 billion in venture funding, a 42% decline from last year and 56% decline from 2021, according to Crunchbase data. But even with much less total funding, round sizes increased, according to Carta data.
"It used to be that any company with good traction and a strong founder could raise money," said Nicole Quinn, a general partner at Lightspeed. "But now you need to have something really special."
VCs have been enamored with generative AI
It is no secret VCs have been enamored with generative AI in 2023, led by megadeals in OpenAI and Anthropic. Having an AI focus has often trumped the kind of metrics VCs have traditionally been attracted to, according to Jake Saper, an investor at Emergence Capital.
"You've got some companies that don't have much of AI focus that have solid traction, but they struggle to raise capital," Saper said. "Then you have companies that have big AI plans, but may not have much in terms of actual customer traction yet, but they're able to attract a bunch of money."
Beyond AI, energy companies have also been popular and consumer and enterprise ones have generally fallen out of favor, according to Lerer. Previous exits for founders are always the most important. But beyond that, Lerer says it has sometimes been harder than ever to distinguish the hot from the not.
"We can meet a company where a deal will get done in three days and another company where we can sit around for six months and see what we think and the companies might not be all that different," Lerer said. "That's the weird part."
These are some of the most buzzy recent seed and pre-seed rounds, according to VCs Insider spoke with:
Manufacturing platform Keychain announced an $18 million seed round led by Lightspeed Venture Partners in November.
SimpleClosure, which helps startups shutdown, raised $1.5 million in pre-seed funding in 24 hours without even creating a pitch deck in a deal co-led by Vera Equity and Cambrian Ventures.
Dream Security, which provides cybersecurity protection for governments, announced a $33 million seed round in November led by Aleph and Group 11.
Guardrails AI, an open-source library for Large Language Models, announced a $7.5 million seed round this month led by M12.
Challenges for VCs and founders
The binary fundraising environment has made it tougher for both VCs and founders.
"Maybe they had to go and speak to five people historically," Quinn said of founders. "Now they have to go much broader. Maybe they need to go back to speaking to 40 different investors to try and get the round done. It's much more time consuming for the founder."
VCs, meanwhile, have had to be more decisive and focused or they risk losing out on hot deals, according to Saper.
"One of the things that it's forced us to do is get to no's faster," Lerer said. "So when we find something that we like can we move ferociously knowing that any deal that we're seriously looking at probably has four or five other groups that are hustling around it."
As for next year, Lerer is hopeful for a less binary market, but he is not necessarily expecting an easier dynamic.
"Our strategy is hope for the best and expect the worst," Lerer said. "Do I think things will open up a little bit? God, I hope so."
