Covenant Venture Capital 2022 Review and 2023 Outlook


2022 Was a Defensive Year Across Asset Classes, but 2023 May Reveal Diamonds in the Rough


The volatile macroeconomic environment of 2022 was heavily influenced by geopolitical unrest and the lingering effects of the COVID-19 pandemic. The pandemic disrupted supply chains and led to a widespread chip shortage. U.S. inflation reached a 39-year high in Q4-2021 and slightly cooled after eight consecutive Fed rate hikes. 


Fed rate hikes have accelerated benchmark lending rates with the fastest increase since 1980; paired with continued threats of COVID disruptions, the War in Ukraine, and inflation, the market is still in bear-market territory. This pull-back in the public markets has also impacted venture capital, despite VC being a non-correlated asset. 


U.S. consumer loan delinquencies have slowly increased with total delinquent consumer assets have increased 34% YoY. Despite an increase in consumer delinquencies, U.S. business delinquencies have remained largely flat, which can be largely attributed to PPP funding and ERTC. Total spending intentions slowed at the start of 2022, but have since rebounded in Q4 with more spend being shifted to durables. This is important because consumer spending and sentiment will directly impact how confident companies and investors are with forward projections, especially for industries in non-essential goods and services.


2022 venture capital performance was certainly a mixed bag. In terms of fundraising, 2022 was a record-breaking year for venture capital. According to a joint report by Pitchbook and the National Venture Capital Association, there was a total of $162.6 billion raised across 769 funds. However, the total exit value was much lower than in previous years. According to the same report, the total exit value ($71.4 billion) was less than $100 billion for the first time since 2016. As a result of high fundraising totals over the past few years, VC firms are sitting on an immense amount of dry powder. According to Gené Teare of Crunchbase, global VC dry powder is nearly $580 billion.






The dry powder, however, is not being deployed at the same pace as in prior years with VC rounds down 80% YoY alone. Moreover, the deals that have been funded at later stages have had round sizes reduced by over half YoY. If there is a soft landing in 2023 and the recession is averted, the economy may slowly normalize over the year and the markets may allow for better IPO environments. This could reverse the downward trend in round sizes and number of large deals getting funded. However, if a recession does occur or if there are continued Fed rate hikes after the February 1st 25 bps increase, we could see further reductions in deals getting done.



In 2022, there were some standout industries that weathered the storm despite macroeconomic pressures, validating our thesis that AI-disrupted industries were likely to be the first to recover post bear-market. Software, commercial products & services, and pharma & biotech secured the largest amount of dollars in mega deals in 2022. Although there was a massive pullback across all sectors, biotech & pharma valuations were still relatively high comparatively. Likewise, enterprise tech and consumer tech remained strong (comparatively), and are seeing faster valuation rises versus other industries. Finally, despite Fintech deal values coming down, the average valuation remains above $400M which reflects the growth and opportunity in the sector.


Heading into 2023, venture capital firms are looking to be more selective with their investments; however, the most attractive startups will solve more complex problems and face fewer challenges in acquiring capital. Our picks for the most intriguing VC sectors in 2023 are healthcare, fintech, software (generative AI), and clean energy. 


Fintech Will Continue to Be One of the Most Sought After Investment Opportunities in 2023


Payments continue to lead Fintech funding by sector in Q3 2022 ($3.4B) and according to McKinsey, generated $1.9T globally in 2021. The Pandemic has accelerated the shift in payment behaviors as we see a decline in cash payments, the adoption of contactless cards, and migration from in-store to e-commerce. New form factors and faster payments are making this segment even more attractive, and even Goldman Sachs has taken notice as they expressed interest in buying and partnering with Fintechs that could help build out their credit-card capabilities which have come under pressure from underperformance.


Consumer-facing payment startups, however, have faced significant headwinds due to the consumer base being the most exposed to negative macroeconomic conditions that have impacted discretionary spending, household income, and purchasing behavior across the board. We are bullish on a slow, steady economic recovery in 2023, and this means that consumer-facing apps will be an attractive Fintech segment this year. B2B fintech payment and facilitator companies have remained robust, and will likely continue to perform well with commercial payments continuing to be a focus for businesses and banks. 


Despite a painful year for Crypto and DeFi, corporate interest and investments in the segment are driving the development of infrastructure, compliance, risk management, and tools that will provide the required stability to help accelerate future growth. The Crypto/DeFi investor still has a long investment horizon as volatility and losses will likely continue in 2023+. Much like personal computing and the internet, market validation and adoption are not at the inflection point that an investor would expect in a late-stage fund. There are still regulatory battles left to be fought and true global buy-in on the efficacy of Crypto before this point comes, but there is no doubt that the underlying technology will be transformative and that this is a sector to keep a close eye on.


Healthcare and the Road Ahead


Venture interest continues to grow in the United States as the healthcare sector in 2021 recorded a record investment of $28.3B in fundraising (PitchBook Data). Investment has receded by $6.5B to $21.8B in 2022. That should not be a shock to anyone who was in the markets during the pandemic as capital influx of the past year and a half has dried up. It is not all negative sounding as the healthcare industry has made leaps and bounds to where they were a decade ago when it was only $3.6B in yearly investment from US investors alone. This newer shift in the market’s desire to find natural solutions for health concerns is a relatively contemporary concept from a commercialized aspect as the old model was affordable and effective. Now the model is natural, affordable, and effective and we have seen this garner more traction as humans statistically in recent decades have become increasingly health conscious. Patients are demanding the best services making it apparent that the reengineering of current technologies is needed. 



Companies that are on the cutting edge of innovation will remain at the forefront of investors' minds. Covenant sees the regeneration of bone and cartilage via patients' stem cell treatments to be one of the most fascinating opportunities. This would allow patients to see virtually no rejection rate which is a remarkable feat considering the traditional average of 3%-10%+ of failures depending on what specific bone is being replaced that we see in synthetic-based implants. Bone implementation is a $47.8B industry in 2021 with projected growth of it is expected to reach around $72.1B by 2030 (Precedence Research). Cartilage repair is a $1B business in 2022 and is projected to grow to $3.9B by 2032 (Future Market Insights). This type of strong growth coupled with growing demand for natural remedies will make the societies of the future that much stronger as we will be able to treat issues at the root naturally. Institutional investors are looking for the finest investments and they should look no further than healthcare as these niche markets solutions noted are ahead of the curve.



ClimateTech & Energy 


While much of the market saw a correction in 2022, climate tech underwent a record-breaking year. Globally, total VC funding reached $70.1 billion, an 89% increase from 2021. A level of urgency has been directed towards the climate crisis, with private funding increases in each of the past three years. 



Historically, Europe and China have led the climate tech sector, but the United States has begun to close this gap. Much of climate tech attention was brought on by congress passing both the inflation reduction act (IRA) and Bi-Partisan Infrastructure Law. Between these two bills, a minimum of $800 billion has been allocated to promote clean energy and sustainable technology through 2030. Private investments have followed suit, and five sectors have seen a rapid increase in funding. 

  • Renewables – Solar, Nuclear, Hydrogen
  • Storage – Batteries, EV charging, Grids
  • Food – Smart Farming, Crops, Livestock
  • Circular Economy – Materials, Recycling, Waste Water
  • Mobility – Vehicles, Micro Mobility, Aircraft

In the U.S., renewables prove likely to lead this space, as the technology has seen rapid advancement. New research conducted at Princeton University, released in June 2022, improved the efficiency of solar energy through commercially viable perovskite solar cells. Moreover, The Lawrence Livermore National Laboratory had a massive breakthrough in fusion energy in December. The team of scientists was the first to ever create more energy than they used in a fusion reaction. Funding for fusion energy has seen a dramatic spike and startups are experimenting with different ways to make the technology commercially viable. According to the Fusion Industry Association’s report, more than $2.4 billion. Notably was the $500 million Series E in Helion Energy, led by OpenAI founder Sam Altman.



As we head into 2023, expect the number of climate tech companies that receive funding to decrease. Despite climate tech having a record level of funding in 2022, it is unlikely to maintain this level through 2023 and will begin to see valuations reflect the broader market. Expect investment levels to grow as the economy begins to recover later in the year, with funding beginning to consolidate into the top companies.


Generative AI


While tech as a whole endured mass layoffs shedding over 97,000 jobs in 2022 - up 649% from 2021 according to Challenger, Gray & Christmas, Generative AI stands to benefit from the increased talent pool and waves of excitement following the release of OpenAI’s DALLE visual transformer and large language model GPT-3. Generative AI solutions were popping up in a wide range of industries and applications over the past year: from pharmaceuticals to media, to manufacturing. According to Grandview Research, the global generative AI market is expected to grow from $8B in 2021 to $109.37B in 2030 at an expected CAGR of 34.6% from 2022-2030. A snapshot of Crunchbase’s listed generative AI startups signals optimism for the nascent industry with funding increasing from 2021 to 2022 despite the turbulence in tech to the backdrop.


Last Equity funding:


The total amount of funding up until the last raise:


One of the main drivers for Generative AI’s growth is the increasing demand from the media and entertainment industry, where technology is being used to form new content, from images to videos to music. In healthcare, Generative AI has seen use in drug creation and as a facilitator in telehealth conversations. In manufacturing, as a method to fill the blank space in designing new products. There is also increasing adoption of generative AI in research fields, for robotics, climate forecasting, protein folding, and material design applications. This is due to the ability of generative models such as Variational Autoencoders (VAEs) and Generative Adversarial Networks (GANs) to conjure new, synthetic data containing underlying patterns and produce predictions that generalize well for the task at hand.


The increasing demand for generative AI in the above industries today is likely to be followed by others who see potential productivity increases through machine-generated content. The dry powder in the VC space could be aimed at significant investments in the technology in the near future, recursively leading to further research and development and an explosion of new products and services. The market for GPT-3’s full capabilities in content generation and conversation AI have yet to be fleshed out, but once third-party developers begin to implement and build upon it, we expect the introduction of specialized generative AI solutions to quickly follow suit changing the way we interact and work with machines.


Heading into 2023, given changes to the U.S. inflation and interest rate environment, our view of Generative AI anticipates valuation multiples for these companies to decrease independent of the underlying tech improvement. The value of future cash flows is dampened by the lower relative buying power and increased borrowing costs. In the past, start-ups tended to be resilient to these trends but risk allocation over the past 5 years made private equities correlate with public equities. In tandem, the promising growth of Generative AI tech and lower valuation multiples suggest promising investment opportunities in the sector going forward.




In conclusion, we anticipate that the first half of 2023 will look similar to 2022, as the Fed continues to raise rates to tamper inflation. The risks of lasting inflation and escalated geopolitical turmoil will impact how many venture capital firms behave. It will be a year of selective funding and consolidation into the best companies. We expect the market to stabilize in the second half of the year as rate cuts are anticipated for 2024. While venture capital is not directly correlated with the broader markets, it will be one of the first asset classes to benefit as market conditions improve. 


While fewer companies will get funded, the companies that solve complex issues and create great technology will have no problems. Much of the attention has been placed on AI companies, largely credited to a breakthrough in LLMs, specifically, OpenAI’s GPT3. This technology will continue to rapidly improve, and disrupt many different sectors. Expect companies with AI solutions to lead the way in 2023.


The venture capital landscape holds many more exciting investment opportunities in the coming years. We are especially excited to see how AI changes healthcare, fintech, software, and clean energy. Even in uncertain markets, this investment strategy has a track record of success. It is our belief that AI is near an inflection point, and we will continue our work in finding companies that can deliver these outsized returns.

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