Christmas Vibes

It is beginning to look a lot like Christmas everywhere. It is also the time when the final boards of the year take place, and the budgets for the next year are prepared. It is a special time as we look back on 2023 and discuss what the next year might look like. And Santa seems to have listened this year...

Software is back.

Earlier last week, I shared this chart from Altimeter with my team. And it has gotten quite some traction in venture land since. Why? Well, it has some Christmas vibes: Software markets are getting better.

While the data is for public companies, the messages coming out of our portfolio companies evince a similar trend on the private side.

Let me give you one example shared by our company Red Points, led by the star CEO Laura Urquizu: ‘Now the trend [of the last months] is consolidating and numbers are very good, even better than forecasted, especially in terms of churn and NRR. [For certain segments] NRR is actually the highest ever. [...] The quality of new revenue is also relevant. We can definitely confirm that after a challenging H1, we have been expanding successfully in the GTM strategy.’

So, not only is it slowly getting easier to sell software with deal pipelines filling up nicely again, but churn is way down and stabilizing. The budget-cutting among software buyers really does seem to be ending, meaning that the software recession that started in early 2022 is very likely over. As you can see on the chart, net growth is not great yet but is in positive territory for the first time in 5 quarters and definitely moving in the right direction over the last two quarters. With churn under control, companies can focus on growth again. It feels like the beginning of a longer trend.

The growth rebound is even more robust in previously high-growth software companies. At the same time, valuations are stabilizing as expected at pre-Covid levels. The message is clear: Back to execution, teams.

On the consumer software side, things felt different over the last two years. Most of our companies grew very well throughout the last year, while improving unit economics considerably across the board. We expect this trend to continue in 2024 in most sectors. 

The big question for markets will be, of course, what central banks will do with interest rates. The consensus seems to be that there won’t be any material raises in the near future; on the contrary, the looming question appears to be not if but when rates will come down. When rates are cut, I suspect capital allocators will get quite excited and fuel stock markets… Many assets that suffered the most from the higher interest rates are already way up over the last month or so, Bitcoin being one of the best examples...

Early signs of M&A.

For things to truly normalize again, liquidity must return to the market. For this to happen, public markets need to look merrier again, and there are some early (and I highlight early…) signs of promise. This was one of the points we mentioned to our shareholders at our AGM: Multiple companies in our portfolio have recently received inbound M&A inquiries. While the M&A market remains dreary, we are seeing the first signs of life...

It is a great time to start developing relationships with potential buyers, to be ready for when things pick up again. Deals can go quickly or take a long time. Some are done within a few weeks, others take months. Today, many buyers feel empowered. They think they can get away with it if they want to take their time. By putting in work up front today, you can shorten the deal timeline and thereby increase execution certainty. Time is the enemy of all deals once things get serious. As a rule of thumb, you don't want a deal to go over 4-6 months. This is not so different from raising venture money: you must keep the momentum up. 'Striking when the iron is hot is so important'.

The pace of venture investing is still low but should pick up.

I expect the pace of venture investing to pick up in the next year.  As was the case after previous crashes, investors will regain confidence and deploy increasing amounts of capital, especially when prices remain reasonable and the market outlook is improving. 

There is a general misconception I have heard many times: Venture funds investing aggressively during a downmarket perform better. First, I think it doesn’t really matter when you invest, as this is a long game. You should get into assets anytime if they are exceptional. Second, venture performance data suggests the best time to invest is right after a bearish market period, not during it. It is simple: Venture returns are tied to business cycles and economic activity. So the best vintages are those right after a sluggish market. A rising tide lifts all boats... Here is the trend of venture returns by invested vintage. Looking at previous downturns, my guess is that the 2022 vintage will land somewhere in between 1999 and 2008 and things will trend upwards again.

This is one of the reasons why great firms have paced down their investment frequency over the last two years. They are still investing, but less. It is difficult to invest heavily when it takes more time to show results. When markets come up again, this is one challenge less (out of the many) to build fast-growing companies. Discipline is all that matters. Luckily, things are starting to look better out there.

This post is a bit shorter than usual. The end of the year is busy. While markets are struggling, entrepreneurship doesn’t. With pipelines ramping up nicely again, there are many things to look forward to. This is also the first year I bought a real Christmas tree in a long time. So many signs point in the right direction for 2024. 😉

Life is awesome

Yannick

European VC Europe