Entrepreneurs are having to adapt to a new normal. On the one hand, they now have access to all sorts of low-cost tools to build their technology offer; and on the other, they are having to create demand before seeking investment. 

“Until quite recently, the venture capital market was an easily accessible pool of capital for founders – in terms of funding discovery around product/market fit and building an initial team,” says Cooper Parry Partner Asif Ahmed. The early-stage venture capital pool was well established and could be tapped into by even pre-revenue businesses which were simply running experiments. 

Investors had a significant appetite for high-risk investments in embryonic companies because, at the time, money was cheap. “There was no interest yield to be had on that money so a lot of investors were simply putting their money to work, knowing that the majority of these investments would go to zero, but some would make a really good return,” says Ahmed. “So investors had the appetite to throw experimental capital at these businesses.”

As of May 2024, interest rates have risen to 5.25%, leaving the cost of borrowing at its highest for 16 years. That is a dealbreaker for many, if not most, venture capitalists.

The cost of capital is king

With interest rates above 5%, investors are getting more return from simply leaving money in the bank. “Venture capital firms questioned whether they wanted to take on the risk associated with an entrepreneur experimenting with their capital,” says Ahmed. “Tolerance has narrowed.”

But interest rates alone are not to blame for the new lending environment. There are a few other dynamics that are feeding into this state of play.

“There’s a seismic shift in technology,” says Ahmed. “AI tools and the proliferation of ‘no-code and low-code solutions’ are plentiful, so even those of us who are not software engineers can develop solutions that underpin a business idea. That’s revolutionary.”

As a result, entrepreneurs are in a strange place. Getting investment is tough, but there is so much that can be done – alone or in small teams – that costs very little. Today, it is viable to develop a proof of concept, build prototypes and determine market appetite for little or no money.

“The sum of those two shifts now determines which businesses will get funded. They will be businesses that, in a really low cost way, use tools to create their early prototypes, create early demand and have already achieved market feedback,” says Ahmed. “But if you are a founder that hasn’t kept up with that trend, and you’re still speaking the old language in today’s environment, there is no market for you.” 

A lot of early-stage entrepreneurs are finding this out the hard way.

All things are cyclical

We have shifted from an investment world where fundamentals pretty much became irrelevant, to one where fundamentals are everything. Investors are chasing a return – that’s what matters.

Of course, there are always exceptions. Whereas marketplaces and direct-to-consumer start-ups were all the rage, now a lot of AI start-ups are being funded – even without fundamental economics in place. “If you can build a pitch deck that sounds like you’re solving a deep problem using AI, then – regardless of your financial metrics – there’s money out there for you because there’s nothing to suggest that you’re wrong,” says Ahmed.

However, it won’t be long before ‘AI’ is an assumed technology, a bit like the word ‘internet’ is today. What will move investors going forward are early-stage businesses that capture large value by solving big problems. 

Talent also matters, especially now so few people are needed to start and run a business. In Ahmed’s opinion, the next wave of high growth start-ups will be solopreneurs, probably supported by direct-to-consumer marketing. And they will be global. Founders will not be restricted in any way by geography; ecosystems are increasingly limitless.

In fact, going global from inception is table stakes. There’s money for that.