This article was contributed to TechCabal by Uzorchukwu Mbamalu
Economic markets and government policies affect global wealth distribution. Major world powers like the US, China, and Japan are heavily involved in making some of the key policies that affect the law of demand and supply and, extensively, global wealth distribution. One such entity is the United States’ central bank, the US Federal Reserve. The US Federal Reserve’s monetary policy decisions, such as interest rate adjustments and quantitative easing measures, can stimulate or slow economic activity, affecting liquidity and investment availability for startups. VC funding provides capital to early-stage startups with high-growth potential, influenced by this global economic liquidity.
To understand this, let’s consider global wealth as a big jar of coins, and that jar represents all the money in the world. When the US Fed decides to make it easier for people to get money, it is like adding more coins to the jar because lower inflation frees up more money for investment and VC funds. On the other hand, when the US Fed decides to make it harder for people to get money, it’s like taking money out of the big jar; this means less money is freed up for limited partners (LPs) and investors to invest with.
The Federal Reserve’s monetary policy can influence venture capital (VC) funding by making it easier or harder for VCs to invest in startups.
How this affects LPs
In essence, the US Fed’s monetary policies act as a significant driver of global wealth and, consequently, VC funding. Policies like these determine the rate at which limited partners provide capital for VC firms to fund businesses.
For instance, when the borrowing cost is high, the interest rate tends to be high. LPs may decide to pursue other forms of investment that guarantee them low expenditure and better returns. Here, government bonds, commodities or stocks make a lot of sense for them.
But in low interest economies, investing in bonds isn’t too clever, as yield is low. Instead, they grasp on straws and invest in companies that VCs analyse to succeed, and hand them capital. They can make a lot more money from equities and business stakes.
In a nutshell, global economic health plays a role in VC funding.
VC funding boom in the 21st century
Between 2020 and 2021, VC funding experienced unprecedented growth due to the Fed’s expansionary monetary policies, resulting in increased valuations and startup activity. In 2021, funding peaked at $345.4 billion, breaking the previous record set by 2020.
Some key activities that shaped these strong performances were:
- US Fed’s expansionary monetary policy at the time. In stark comparison to 2023, the US Fed fund rate was drastically reduced between February to April 2020, from 1.58% to 0.05%—stimulating the economy and landscape for VC funding.
- Remote work and the SaaS boom produced more founders and startups.
- VC firms had amassed considerable capital in the years leading to 2020. This ample supply of cash enabled VCs to actively pursue and invest in promising startups.
- An estimated 20% of funded companies were successful after raising in 2020. This gave VC firms more confidence to pursue deals in technology, fintech, and health-tech startups.
- Blockchain’s stock skyrocketed during and after COVID. Investors wanted a piece of that pie.
- The drive for early adoption of technologies backed to be the next big thing increased investment activity.
- The performance of the stock market, particularly in the technology sector, reached record highs during this period. This success fuelled investor confidence in the potential of early-stage startups, further incentivising VC funding activity.
VC funding challenges overtime
One major challenge for VC funding, however, has been the decline in global liquidity and increasing risk aversion among investors. This has made it more difficult for VC firms to raise capital from investors, which has in turn reduced the amount of money available to invest in startups.
Despite these challenges, there are still opportunities for startups to attract VC funding. Let’s take a look at the trend last year.
The AI boom
Sectors that traditionally led raising rounds like IT, business and financial services, and healthcare all fell behind by 35% in 2022.
This could potentially point towards the future of investment tilting towards AI technology. Thankfully, the place of innovation will never be overlooked by investors. Startups innovating in these sectors like finance, healthcare, and education are still getting funded. But the new trend is with companies that are using artificial intelligence for industry solutions in finance, healthcare, and education.
Global wealth prediction
Credit Suisse predicted global wealth of emerging economies to grow by 6.5% over the next five years. During this same time, Statista has also forecasted inflation to reduce to 5.79% as early as 2024 and 3.83% by 2028.
This would allow economies to operate open markets. With this, the US Fed is expected to lower borrowing costs soon and turn the lever for more expansive monetary policies. This will in turn recreate all the occurrences that happened in the 2020–2021 VC funding boom.
Here’s what the prediction might look like:
- Fed will reduce the federal fund rates—although we may not get as low as the central bank’s 2% rate just yet.
- SaaS startups are still moon-shooting in 2023—we’re still seeing the trends in healthtech, fin-tech solutions, blockchain, artificial intelligence, and more. With more companies documenting their APIs, the barrier to SaaS startup founding is getting lower, and this means more innovation from founders in a few years.
- Low inflation will open up more funding from LPs that VC firms can use to invest in companies.
- Specialised VC funds in cleantech, for example, quickly shaping the VC landscape.
How to prepare for the next round of VC funding
The trends happening in the world of global finance point towards a VC funding boom happening soon. This is predicted to happen around Q4 2024 or early 2025.
However, as a startup founder, you have to be ready. Bootstrapping businesses looking to attract VC funding in the next wave should focus on the following areas:
- Set up a good structure: VCs are redefining deal closing tactics and risk analysis. Founders should establish a strong team, develop a unique value proposition, and clearly define their business model, market address, and buy-ins.
- Get traction: If you demonstrate revenue traction for your business and can prove that you can break even in every financial year, you will be good in the eyes of VCs. Showcase early traction and validation of your product or service.
- Adapt to changing market conditions: Find the trends and understand the next wave happening in your market. Be prepared to adjust your business strategy and financial projections as market conditions evolve. For example, adapting artificial intelligence into fintech solutions.
- Build relationships with VCs: Network with VCs and industry experts to gain insights into their investment criteria and preferences. Seek advice from experienced entrepreneurs and investors who can provide guidance.
- Prepare: Get ready to answer detailed questions about your company’s financials, business model, market strategy, and intellectual property. And demonstrate transparency throughout.
Essentially, VCs are willing to bet on founders and businesses that can demonstrate adaptability, resilience, and a commitment to long-term growth. Businesses that are not well-positioned run the risk of capturing opportunities to secure the needed funding.
The recent hit in the VC funding landscape is only reflective of the fluctuations in the broader economy, and there are still opportunities for businesses seeking to attract capital. With the anticipated lowered rates across inflation and federal funding rate, startups should begin to gear up for the boom coming. Businesses that stay informed, build strong relationships, and prepare for the challenges ahead will be well-positioned to thrive.