Which sectors are getting VC investment in 2023?

Startup businesses attract investors because they innovate, create new ideas and develop products to fill a current business or consumer need. Investors back startups to bring new ideas to market faster than established businesses.

Investors want to find the next disruptor for specific industries, the startup with an idea that could fly and potentially become synonymous with a product or service as Rightmove is to property search.

The risk to investors

For investors though, investing is risky. According to GOV.uk, 753,168 new startups were founded in the UK between March 2021 and March 2022, but just 4.3% of UK startups are showing high growth and the average five-year survival rate of UK startups is 42.4%

2023 investment climate

“Overriding themes for 2023 are to invest in higher quality businesses that are further developed compared to 2022 when the funding landscape was easier,” said Nicholas Hyett, Investment Manager at Wealth Club tells Startups.

Global recession was expected in 2023. The UK economy actually grew 0.1% in Q1 and could grow by the same margin in Q2. Despite avoiding recession, the economic headwinds that dominated 2022 continue, with the war in Ukraine, high inflation and rising interest rates affecting consumers’ spending power and investors’ appetite for investment.

Which sectors are currently investable?

During periods of economic volatility, investors and venture capital (VC) companies look for defensive stocks to invest in. This includes sectors like utilities, healthcare and consumer staples. Defensive sectors are relatively stable and historically provide consistent revenue growth during economic downturns because consumers still need to buy medicines, pay utility bills and buy food.

“Investors are looking for startups that can break even quicker and where the development cycle is faster,” says Hyett.

B2B is more attractive to investors currently because businesses still need to invest, whereas in a cost of living crisis, consumers limit spending and hold onto cash.

Real Estate is also a defensive stock. The sector includes fintech companies providing technology products to create efficiencies in areas that support property transactions. Fintech’s are the most successful startup sector in the UK, according to private company data provider Beauhurst.

“Fintechs are attractive as they are often software driven, with low variable costs and lower capital intensity,” explains Hyett. “If your startup is building a product to make financial services work faster and more efficiently, you will find investment.”

“What is also attracting investors are classic VC sectors: SaaS, and parts of the healthcare sector – diagnostics, not drug development.”

This is partly a hangover from the pandemic when investors wanted to back companies to find a COVID-19 vaccine. The focus is now on medical devices and diagnostics, “because they have short development cycles and are not capital intensive,” explains Hyett. Drug development trials take several rounds and can then get vetoed, providing no return on investment.

“These classic sectors account for a higher proportion of overall funding than 12 months ago. This is due to the resilient nature of the sectors,” Hyett concludes. 

Outlook for 2023

Higher interest rates make investment more expensive. This means investors are looking for slightly more developed businesses that can clearly illustrate a route to market, can become break even or profitable quicker and have relatively lower costs.

VCs want to support existing businesses in their portfolio with their next stage of development. So, if you have investment already, you have an advantage,

However, certain investment funds and VC portfolios, depending on their nature, will always want some new businesses to invest in as part of a fund’s investment mix.

“Most fund managers want a blend, so there will be some new investment in startups,” states Hyett. “If you are a startup, it’s all about showing how far down that journey you are and how close you are to being genuinely self-sufficient.”

What qualities do startups need to attract investment in 2023?

To get investment now, new companies need to meet a higher bar than in 2022, sadly even more so for female founders. But in tough times, quality often rises to the top. Investors know that attractive businesses who survive and prosper now will be the success stories of the next decade.

According to Jonathan Symcox, Editor, BusinessCloud & TechBlast, who recently launched an event for early stage and pre-seed companies, Manchester 2.0, there has been a change in 2023. Gone is the US west coast mentality more prevalent in the UK in 2021 and 2022, where startups had to convince VCs of their vision and how they would become a billion-dollar company, a kind of ‘You have to fake it to make it’ mentality.

The UK tends to be more cautious. So, in 2023, angel investors want to know a businesses current status, what they are doing now and when it will make money. “Rather than be obsessed with becoming a unicorn, be obsessed with making a smaller, sustainable profit,” emphasises Symcox.

He cites the example of West Yorkshire data science business Frame. Founded in 2020, the company reached £1 million in turnover nine months ahead of schedule, aided by its founders being experts in their field. This helped them develop a business with tangible aims and results. Its data services and AI systems are in demand from the retail, FinTech, eCommerce, software and education sectors.

“Increasingly investors want to know that people within the business understand the technology or product and can illustrate how value is delivered,” stresses Symcox.

What attributes do startups need to show investors?

“That depends on the VC,” says Hyett. “VCs are often sector specialists and requirements vary by sector. For retail they want brand strength and recognition, but the requirements for fintechs are different, they want to see industry connections and innovation.

“But, they want to see a route to profit for all sectors,” adds Hyett.

Startups need to show there is a need for what they are developing. “Simply deciding what you think the market wants is not going to work,” says Symcox. “Startups need to listen to the market, not dictate to it.”

The ability to create pivotable technology is also important. Investors will look at the personal qualities of business leaders too.

“Having the knowledge, humility, ability and intelligence to be flexible is important,” said Symcox. “Can you incorporate new ideas into your business?”

Another key attribute for founders is to be able to loosen their grip on “their baby,” the business they have sweated over and dreamed about.

Investors want startups to show that their product actually works, with live clients and demonstrable revenue streams. Investors can then show startups what they can achieve by adding funding rocket fuel to their business.