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2023 Year in Review

As we close the chapter on 2023 we wanted to reflect on the massive shifts that have shaped the venture landscape this year, how Conversion Capital has navigated these turbulent times, and what themes and technologies we are most focused on in the new year.

The pandemic of 2020, and the subsequent three years of volatility has led to a rollercoaster of change, disruption, and mini cycles throughout the world. With little to no playbook to serve as reference, one must rely on first principal decisions which prevail during similar times of volatility. Preparation, vision, hard work, and discipline to execute. In our 2020 investor presentation for Fund III, we focused on four key themes which prevail till this day:

1. US led recovery: The United States would lead us out of a downturn and decouple from global economies.
2. Technology first: Technology would emerge as the biggest winner and penetrate every business in the economy led by cloud, software, and data (AI/ML).
3. Early-stage vs Growth: Emerging early-stage technology will be the greatest single opportunity and growth will be challenged during this cycle.
4. Timing is everything: Patience is the ultimate virtue and not easily expressed in asset management.

Woody Hayes, the legendary football coach from Ohio State once said “‘You can have no great victories in life unless you can overcome adversity. The War in the Pacific was the greatest military victory of all-time because of Pearl Harbor, and the adversity we had to overcome because of that.’ The last three years have proven to test not just the business world, but what feels like insurmountable adversities for individuals, families, and society alike. Yet what’s important to remember is that patterns and cycles happen, but wars, downturns, and pandemics don’t last forever. Big problems that never seemingly go away are usually a man-made phenomenon, and while 2024 may be volatile, we remain committed to managing through the challenges.

2023 Year in Review

We have recognized for some time that we were at the tail end of a technology super cycle; SaaS and cloud megatrends have matured. Yet, amidst this late-stage environment, the pandemic sparked a massive bubble fueled by monetary and fiscal policy, along with a smaller wave of COVID-specific innovation, such as remote work, cybersecurity, e-commerce, and telehealth (among many others). However, the unprecedented surge in venture funding, fueled by the Federal Reserve’s aggressive rate cuts, led to a market awash with capital. A staggering $420B+ in new inflows sparked a period of diminished investor discipline, and traditional boundaries were blurred as hedge funds, mutual funds, and family offices eagerly entered the venture space. This influx of capital, lacking pricing discipline, led to inflated valuations and the emergence of 500+ new “unicorns” in 2021 alone. The IPO market initially thrived, yet profitability at exit saw a significant decline. Venture firms expanded aggressively across geography, stage, team size, and investment velocity. This was simply not sustainable, and the aftermath is being felt today. Some metrics show 50% of the Venture Capital firms in existence today won’t make it due to ill-timed decisions during this period.

Everything changed in 2022 with the Fed’s rate hikes, which served as a stark wake-up call, constricting the previously buoyant IPO pipeline and signaling a shift towards normalization (and a strong investor preference for profitability over growth at all costs). As we navigated through 2023, we witnessed a recalibration of public and private market valuations. The growth market felt this adjustment acutely, with valuations plummeting by over 50% compared to the previous year. This new reality compelled tech companies to reassess their spending and burn rates rigorously. The venture industry itself underwent a period of introspection and restructuring as well. Many funds, having raised excessive capital, found their operations bloated and inefficient. This period also exposed weaknesses in risk management practices, highlighted by the collapse of SVB amidst the highest rate of bank failures by assets since the Global Financial Crisis. Moreover, the broader macro landscape has been fraught with emerging (and worsening) challenges, from escalating nation-state tensions (ex. China/Taiwan, Russia/Ukraine, Iran/Middle East), anemic economic growth, inflation, and social unrest.

Looking ahead to next year, our strategy is rooted in identifying and capitalizing on transformative themes and trends in a rapidly evolving landscape of technological innovation. Below, we outline some of the key areas we are observing and believe will drive large change.

1. Artificial Intelligence: The field of Artificial Intelligence is currently in its implementation phase, marked by an extraordinary influx of capital, especially during the years 2022-23. Notably, the United States is leading this investment surge, surpassing the combined investments of all other nations. This substantial financial commitment, primarily directed towards infrastructure development, promises to yield significant efficiency improvements across various sectors. Consequently, it will create a landscape of both opportunities and volatility within industries and capital markets. We now find ourselves on the precipice of witnessing the emergence of what can be considered the ultimate AI form. Alongside this development, the adjacent opportunities in data infrastructure stand out as particularly enticing. These opportunities raise fundamental questions about data collection, packaging, and security. The strategic unbundling and bundling of data assets offer a unique advantage, enabling highly technical teams to harness AI tools and construct pioneering businesses with streamlined operations and minimal capital investment. Furthermore, other technological advancements will continue to reinforce the growing divide between the United States and China in comparison to the rest of the world. This divergence will result in a significant imbalance in global economic prosperity. Ironically, this global dynamic will lead to increased volatility domestically and a return to core values abroad. It is essential to not underestimate the impact of the US economy and consequently, the US stock market in this evolving landscape. Additionally, we hold the belief that small and mid-cap technology stocks will maintain their momentum, especially as the Federal Reserve signals future rate cuts, further enhancing their attractiveness to investors vs private growth opportunities.
2. The United States Will Drive Economic Growth: Considering the upcoming election season, it is worth noting that a robust U.S. economy has become a pivotal factor in determining electoral viability. We find ourselves at a crucial juncture in our domestic political landscape. It is noteworthy that the first developed nation to raise interest rates will likely be the first to embark on a path of economic easing. In this context, the U.S. economy stands to gain substantially, benefiting from the resolute efforts of the Federal Reserve to stabilize this economic engine. Moreover, when viewed in the global context of lackluster economic growth elsewhere, the United States is poised to attract significant capital inflows into its domestic companies. This phenomenon is expected to make U.S. based assets an exceptionally appealing asset class, one that should not be underestimated or overlooked by investors and economic analysts alike.
3. Tis the Election Season: 64 Countries plus the European Union, roughly 49% of the world, will hold national elections in 2024. Elections to watch: United States (November), Taiwan (January), Pakistan (February), India (April), Mexico (June), and EU (June). It’s worth noting that the average age of political leaders globally is getting younger and younger, and a shift to potential and momentum is happening. According to Freedom House, the median age of countries classified as “not free” is 69, compared to the median age of “free” countries at 58. The United States and Namibia are the only “free countries” with a political leaders aged 80 or older.
4. Conflict will give rise to increased investment in National Security Technology: In the present geopolitical environment, characterized by escalating tensions and growing threats to vital infrastructure, it becomes increasingly evident that the technology sector must play a pivotal role in enhancing national security. The United States’ defense industrial base confronts a pivotal challenge due to its constrained domestic manufacturing capabilities, often described as ’empty bins.’ This predicament underscores the necessity for a concerted effort to bridge the gap between physical, software, and data infrastructure enhancements. This convergence represents a pivotal nexus where technology can serve as a potent force multiplier for strengthening our national security apparatus.
5. Near-Shoring and Cross-Border Investment: The growing prominence of near-shoring practices in recent years has led to a notable transformation in trade dynamics, particularly within the North American context. The trade relationships between the United States, Mexico, and Canada have assumed unprecedented importance. This evolution necessitates the development of advanced payment structures and regulatory compliance frameworks to facilitate more extensive and frictionless cross-border collaborations.
6. Demographics as Destiny: The baby boomer generation owns 2.3m businesses in the US. Many of them are cash flowing machines, with no succession or transition plan in place. As the demographic shift in North America (and globally) continues to change, with a significant portion of the population aging, we believe there will be a myriad of opportunities in sectors such as at-home care, fraud prevention, longevity, and retirement planning. By 2030, with 21% of the population aged 65 and above, innovations in these areas will not only be in high demand but also essential for sustaining quality of life and economic stability.
7. Fintech’s Next Evolution: Financial services are at a pivotal juncture, requiring a significant upgrade in cybersecurity and fraud defense mechanisms. The integration of AI/ML functionality across the financial stack, from back-end to front-end processes, is rapidly becoming a necessity rather than a luxury. Additionally, the slow but steady rise of A2A payments poses a formidable challenge to the traditional card ecosystem, signaling a major shift in how financial transactions are conducted. As we look ahead, we believe embedded fintech will continue to draw investment, leveraging the consumer centric adoption during the e-commerce boom, and have breakout growth across every aspect of financial innovation.
8. Hyper-Personalization for All: We are witnessing the next evolution of SaaS, where the one-size-fits-all approach is making way for hyper-personalized iterations of products, leveraging AI to tailor user experiences. This trend is particularly pronounced in sectors like healthcare, financial services, and education, where personalization can lead to significantly improved outcomes and user satisfaction.

We are excited to pursue these opportunities and many others in 2024.

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