Telstra Ventures’ Insights on the Investing Landscape in 2024

After a difficult 2023, expect to see a modest recovery in VC valuations and deals next year – even though economic headwinds (such as inflation, high interest rates, and the looming threat of recession) will continue to put a brake on these numbers. While the economic environment will be difficult to navigate in 2024, there will also be huge investment opportunities for VCs that know where to look.

With all those factors in mind, let’s take a look at how Telstra Ventures partners are thinking about the economic, technological, and investing landscape as we enter 2024.

AI adoption will become more results-driven

Telstra Ventures Managing Director Matthew Koertge believes “2024 will be the year where the world better understands the true potential of generative AI.” He explains:

“While AI has been around for many years, ChatGPT demonstrated how impactful LLMs can be. This technology will find powerful applications in areas like content creation, entertainment, business processes, personal assistants, customer service, healthcare, and education. Generative AI will boost productivity by freeing people’s time for more high-value work, creativity, and innovation.”

General Partner Marcus Bartram anticipates that generative AI will “move from testing and experimentation to mainstream production across enterprise. We will start to see vertical-specific LLMs emerge and gain traction, displacing more general LLM models in specific sectors. Models will be complemented by other analytical and decision models to improve outcomes, so it won’t be a one-size-fits-all market.” Investor Eugin Lee observes that the “market prefers platform solutions” as opposed to “many different point solutions.” She continues: “Even in the current generative AI market, we are seeing this dynamic where incumbent platform solutions that embed AI into existing products have an advantage over startups building AI-native point solutions.”

General Partner Saad Siddiqui discusses how companies are integrating AI and pursuing competitive differentiation:

“Existing SaaS vendors are integrating generative AI into their product portfolios. Startups that are looking to be the generative AI version of specific categories will struggle as existing software platforms build out competing products and customers look to consolidate their vendors versus looking for new vendors. It is critical for startups to find a way to innovate on the business model (Siebel versus Salesforce, for instance) and/or acquire a valuable differentiated dataset. The startups that are able to figure out both have the potential to be generational companies.”

While it’s clear that the AI revolution is underway, General Partner Steve Schmidt cautions against getting caught up in the hype next year:

“Aside from a few AI-specific use cases, most generative AI companies will experience a deep sales and revenue recession in 2024. Enterprise customers will see past the current crop of ‘generative AI card tricks’ and spend more time preparing to buy this technology in 2025 and 2026 when it becomes more ‘enterprise ready’ at scale. Realizing it doesn’t yet make sense to put an AI turbocharger on their legacy horse-and-wagon workflows, enterprises will first prioritize a series of more modest modernization and complexity reduction projects.”

The partners are paying close attention to how AI intersects with other fields and industries. For example, Siddiqui points out that “Vertical SaaS will continue to accelerate. Generative AI creates enough of a gap between legacy vendors and new startups that customers will start gaining significant value from these solutions.” Bartram notes that “cyber activity and regulation in the generative AI market will continue to drive opportunities for early-stage technology in this sector.” He also observes that companies are working to mitigate the threats posed by AI: “Cybercrime will be hyper-powered with LLM capabilities, so insurance is beginning to figure out how to underwrite the risks from generative AI.” Schmidt believes the “confluence of AI and robotics will start to become a commercial reality beyond the Fortune 25.”

Although Managing Partner Mark Sherman notes that “AI will continue to be the largest sector of U.S. VC investing in 2024,” he also warns that “AI will have an entire hype cycle that may take two or three years to play out.” With those caveats in mind, the partners remain bullish on AI. But they also recognize that VCs will need to soberly assess the concrete value AI startups and applications are capable of generating in 2024 and beyond.

Economic instability will persist

Despite some encouraging economic news over the past several months (about slowing inflation, for instance), the global economy still faces daunting challenges as we enter 2024 – from slower growth projections to interest rates at their highest level in decades.

Sherman summarizes this muddy economic picture: “Current risks such as geopolitical volatility, political instability in the U.S., energy market worries, and recession concerns will mitigate improving growth and profitability in earnings reports, better inflation and interest rate outlooks, and measured increases in jobs and unemployment.” Koertge notes some of the practical implications of the potential economic slowdown:

“Next year, we’ll see more high profile unicorns like WeWork filing for bankruptcy. Emerging tech companies will try to reduce their cash burn, while companies in many industries will lower their forecasts. It will be a challenge to continue growing revenue given the pressures from inflation, interest rates, and reduced consumer spending.”

Bartram expects that the “United States will be in a recession by Q4 2024 and tech companies will continue to reduce their workforces,” but he notes that VCs will be able to capitalize on these economic conditions, which create an “opportunity for investment as prices remain depressed despite immense technical talent in the market looking to create the next generation of disruptive companies.”

One consequence of less-than-ideal economic circumstances and tightening budgets is the increased pressure on companies to demonstrate their performance. As Lee observes: “More and more companies are establishing ‘vendor review councils’ internally to scrutinize new software purchase decisions.” She explains how these councils work:

“After the advocate of the software purchase submits the order for approval, the software review council determines if the software tool is actually needed, the level of importance, prioritization of budget, etc. For B2B software companies and startups, this means proving that they are a ‘must-have versus nice-to-have’ and demonstrating a hard dollar ROI to customers.”

The global economic situation will affect companies differently depending on their industries. For example, Partner Albert Bielinko observes that the “wind market will continue to face heavy challenges as some of the largest wind companies go bankrupt on the back of higher interest rates and escalating project costs.” On the other hand, Bielinko thinks “Data companies which facilitate trust in renewable markets like *Pexapark will have a strong year as the need for data on power purchase agreements and software to manage volatile electricity prices increases.”

Schmidt is particularly worried about the economy in 2024: “With the Fed unable to lift interest rates, inflation could rise again and eat away at consumer purchasing power, which may cause a recession and a steep drop in enterprise spending. If this is the case, the breakneck speed of embracing innovation would slow dramatically, while companies would explore new technologies more cautiously.” Major tech companies have already been forced to downsize, as Sherman explains:

“Google, Meta, and Microsoft will continue to grow revenues, but they will have roughly 10 percent fewer employees five years from now as AI productivity improvements cannibalize growth and absorb support, marketing, development, and administrative roles. At the same time, slowing revenue growth rates will drive campaigns to find operating expense efficiency.”

While there are several positive economic indicators, the partners believe expectations should be tempered with an honest acknowledgment of some harsh realities: the Fed has signaled that interest rates will remain high for the foreseeable future, companies are scaling down their projections, and the threat of recession remains very real. However, this shouldn’t prevent investors from taking advantage of attractive valuations for great companies.

The state of VC and emerging tech in 2024

What does all of this mean for VCs? While 2024 will be a recovery year for many VCs after a difficult period of declining deal flow, exit values, and index returns, there are also major opportunities in sectors ranging from AI to cybersecurity to climate mitigation.

Sherman projects that VC investing in the United States will “recover modestly in terms of dollars and deals, and we’ll see an increase in the number of unicorns.” However, he believes economic conditions will limit growth. Koertge sees a mixed picture for VC as well:

“VC valuations and deal terms will be very inconsistent in 2024. Some companies will raise capital at irrationally high valuations and others will struggle to do so at very low valuations. A lot of emerging tech companies are going to come back to the private market because they need to raise capital. There will be more complexity in cap tables and deal structures due to pay-to-plays and re-caps. Many companies have massive liquidation preference stacks, complex shareholder approval mechanisms, and in some cases, debt. This will create conflicts between founders, management teams, common stockholders, investors, preference shareholders, and debtholders.”

Schmidt observes that many startups face more formidable financial constraints than they anticipated, but he also emphasizes the unprecedented opportunities in the tech sector: “Given the softness in enterprise spending, VC-backed startups that thought they had transitioned to a cash flow breakeven plan now realize they need a more radical strategy. Meanwhile, VCs are starting to invest more heavily in new companies focused on deep technical problems that will take years to solve but offer a huge step change in capability.” Founders will need to get accustomed to more stringent conditions in 2024, as investors deploy capital more cautiously.

Telstra Ventures’ CFO Geoff Dolphin explains what this new normal will look like:

“In all but the most competitive deals, terms will be more investor-friendly. They will include participating preference shares, liquidation preference multiples, guaranteed dividends, and other sweeteners. This will be a shock to some founders, who haven’t faced such deal terms over the past ten years. Cash generation and a concentration on unit economics will replace growth at all costs. Conversely, although their terms have improved, it will take longer for investors to grow their portfolio companies enough to generate decent exit proceeds.”

Shifts in consumer behavior have led to new e-commerce platforms and forms of brand engagement. As Lee puts it: “Consumer awareness on sustainability has increased and sustainable fashion has gained popularity.” This is why she expects to see “growth in the infrastructure that supports the re-commerce market”:

“Wave 1.0 was the rise of generic marketplace platforms, such as Facebook Marketplace and eBay. Wave 2.0 (where we currently are) was the rise of third party marketplaces focused on certain clothing types, demographics, and distribution channels, such as The RealReal, Poshmark, Depop, etc. However, brands have been left out of the third-party marketplace ecosystem, as they don’t have exposure to or receive data from external marketplace transactions. Brands are incentivized to capitalize on the consumer demand for resale by owning the resale process of their own items and sharing the profits.”

VCs are focused on a range of transformative and fast-emerging technologies. For example, Bielinko thinks “solar will continue to accelerate dramatically, with total 2023 additions well over 400 GW as design and project management software like *OpenSolar facilitates efficiency. Solar panel prices will remain very low as oversupply continues, and in 2023, U.S. battery attachment rates hit a record high despite the elevated cost of capital.” Bielinko also acknowledges that other forms of climate change mitigation are running into trouble:

“A significant percentage of large corporations will realize they do not have a credible route to decarbonization. The per-ton costs of industrial direct air capture facilities will be shown to be dramatically higher than previously forecast… The voluntary carbon market will experience a slow and difficult year as corporate buyers continue to take longer to approve the very small number of high quality carbon projects that exist.”

Climate tech isn’t the only field facing a tough 2024. Siddiqui points out that “HR tech may struggle next year, especially companies that are based on price-per-employee business models.” He continues:

“Customers are looking to reduce costs and headcount going into the new year as the impact of higher interest rates starts to be felt. For companies in this space, it is going to be important to win more logos. ASPs will start to shrink and sales cycles are going to get longer. It is going to be important to save cash, and as the next bull cycle comes, these companies will become extremely valuable.”

Bartram says large companies are eager to work with startups in rapidly growing fields like cybersecurity, but they will demand more accountability: “Enterprise appetite to work with early-stage cyber companies will remain constant, but the bar will be higher for these companies to engage with design partners and customers – demonstrable outcomes will drive purchasing decisions. Companies that have landed will need to continue innovating at an increased pace beyond their initial product to reduce churn risk.” Bartram anticipates that “Cyber budgets will stay flat for the next 12 to 24 months, so prioritization, analyzing costs at a granular level, and understanding risk trade-offs will all be critical.”

This vigilance is crucial for companies across industries. As Lee explains: “In 2024, companies will pursue efficient growth versus growth at all costs. The CFO and business unit leaders will closely monitor operating costs and cash burn. Real-time visibility into actuals versus budgets for each expense, real-time predictions, and scenario planning will be crucial capabilities.” These comments reflect a general theme: VCs can be optimistic about the trajectory of revolutionary tech like AI and fields like climate and cyber without letting hype cloud their judgment. At a time when the global economy is still in a precarious state and VC is recovering from a difficult year, excitement has to be tempered by prudence.

*Signals an investment of Telstra Ventures