Last year ended with fewer startup funding deals and less capital invested than in 2022, but that didn't cool the artificial intelligence boom that has captivated investors since the release of ChatGPT.
In fact, $1 out of every $3 invested went into AI companies during the year, according to the year-end Venture Monitor from PitchBook and the National Venture Capital Association, comprising roughly 20% of deals.
In general, VC investing nationwide returned to prepandemic levels in 2023 with $170.6 billion invested in tech companies throughout the year, slightly less than 2020 numbers but way less than the inordinate $348 billion invested in 2021.
That said, nearly $17 billion (10% of the annual deal value) went to AI platforms Anthropic and Open AI.
Nationally, deal activity saw a slight increase in the fourth quarter from Q3, though it was nearly 28% off the best quarterly output in 2022.
PitchBook analysts indicated it would be a mistake to declare the market in crisis, but near-term relief should not be expected. There is some good news, however, with areas like AI, life sciences and clean tech attracting significant levels of both public and private investment. Generative AI saw 389 deals for $23.9 billion in 2023 nationally, PitchBook data shows. There were 264 such deals for $4.1 billion in 2022.
In Chicago specifically, Stephen Ross, principal at Hyde Park Angels, thinks a slowdown has been apparent, though he's starting to see it pick up to begin the year.
"All the numbers have shown that there's been reduced investment activity, and [according to] the incidental conversations I've had with other investors, people invested less last year," he told Chicago Inno. "For us internally, we were about on pace with our investment case."
Hyde Park Angels targets anywhere from six to 10 deals each year. The firm completed six deals in 2023, and Ross anticipates being at that six-to-10 pace again in 2024.
PitchBook data shows that Chicago saw 70 deals for a deal value of $480 million in Q4 2023, down from $626 million invested in Q3. The largest deal of the quarter came when AI-powered logistics startup Loop landed $43 million with backing by J.P. Morgan. It was the only deal of the quarter over $40 million in Chicago, according to PitchBook data. In Q3, there were three deals that were over $80 million, and in Q2 there were five deals over $50 million.
How the VC shift to AI is impacting Chicago startup investing
As more VCs back AI platforms and models, Ross and other local investors want to be cautious when it comes to the new technology.
HPA recently invested in Chicago-area AI fintech platform Alphathena. The platform aims to provide more registered investment advisors with personalized strategies and investment tools to change the way they can manage their clients portfolios.
"The way we view AI is that the ChatGPTs of the world are very exciting, but we're looking more for what the business use cases around it are and how the application is creating unique value," Ross said. "AI places an incredible valuation premium on these investments, but I think that just because you're AI doesn't mean you'll be successful. It's less about the AI and more about how the AI is being deployed and how it's being used."
Ross and HPA want to invest in AI that enables new business value creation, not just "AI for AI's sake."
"There's numerous situations where a company says it's 'AI for this' or 'AI for that,' but what is the AI actually enabling in that particular use case? Is it providing better forecasting, providing better routing, providing better access to data or better recommendations for decision making?" Ross said.
With Alphathena, for example, Ross said that while the company has an AI component to it, AI is not the focus of the platform.
Landon Campbell, general manager for Drive Capital Chicago, which set aside $80 million in 2023 to invest up to $500,000 at a time in "overlooked" founders, is taking a similar approach.
"There's going to be a lot of folks that are just sort of adding .ai to the URL or just saying that they're AI-enabled," he told Chicago Inno.
Like Ross, Campbell, wants to find the founders who are leveraging this technology in unique ways.
"We're looking for the needles in needle stacks," he added.
Investor discipline of 2023 here to stay in 2024
To kick off 2024, Ross is starting to see a fair number of HPA portfolio companies go out for follow-on financing and getting interest not only from Midwest investors, but also from coastal investors. One piece of advice he'd have for young founders is for them to manage their cash effectively.
"You have to understand that financing cycles are taking longer than they had in the past. During peak 2021, we were [completing] deals in a month. I think now we're looking at more of a classic three- to six-month timeline to get a deal done," he said.
Dry powder — or money that has been committed by investors but not yet spent — will also be something to watch in 2024. The market remains full of dry powder, according to PitchBook, and companies with strong financial metrics will continue to get funded. However, the fourth quarter was also the least active in terms of pre-seed and seed deal value and volume.
"From our perspective, we still have plenty of dry powder and strong interest from our membership to continue to invest," Ross said. "Even though there's all this dry powder, I don't anticipate there being an avalanche of interest where everyone feels obligated to deploy this year and is back to writing checks in businesses that maybe don't necessarily fit their profile. People are going to remain disciplined, and as a result, it just may take a little bit longer for that dry powder to make its way through the system."
