After a record-breaking 2021, venture capital activity slowed in 2022 as macroeconomic uncertainty and a correction in public markets put a chill on investments. As of the third quarter of 2022, $7.2 billion had been invested across 520 venture deals, down from $11.8 billion in 568 deals during the same period last year, according to the Canadian Venture Capital & Private Equity Association’s November report. With the end of lofty tech valuations and investors expecting a tighter fundraising market, VC deals are likely to remain soft in 2023.

The Logic spoke to nine leading Canadian venture capitalists about emerging sectors, valuation levels and what comes next for the fundraising market after a more challenging year. Here’s what they expect in 2023:

Artificial intelligence, real applications

A December report by the management-consulting company McKinsey & Company found that AI adoption has more than doubled since 2017. Many of the VCs The Logic spoke to said they are paying attention to how startups use artificial intelligence in their business processes. There has already been a lot of investment in the fundamentals of AI, said Two Small Fish Ventures co-founder and managing partner Eva Lau. She said she expects to see growth in investments into AI’s applications in 2023.

“For the application layer, I expect that there will be a huge boom, especially with the investment that we have seen already in the fundamental layer,” Lau said.

Phoenix Fire general partner Danielle Graham said investors will be looking out for AI applications that help manage and analyze data collected by companies.

“How you manage your data, how you’re able to showcase effective analytics around it, and learn from all of the data that you’ve been collecting and deliver it effectively—that’s the new gold and the new oil,” she said.

Version One Ventures general partner Angela Tran echoed that prediction. “Just like how every company had to think about their mobile strategy at one point … the time has finally come for AI,” she said.

Believing in blockchain

After the cryptocurrency sector’s meltdown in 2022, Lau and Panache Ventures managing director Patrick Lor said that the focus in 2023 should be on blockchain technology itself.

“There’s a lot of money that’s gone into [blockchain], a lot of research and a lot of expertise,” said Lor. “And now that the hype cycle is gone, all the people that were in it just for the momentum … The real technologists, I believe, are sticking around.”

Lau noted that many have concerns about the crypto sector. “I personally believe that the technology itself is transformative,” Lau said. “I pay keen attention to how blockchain technology continues to mature and become scalable.”

A broadened ESG lens

Although the number of climate tech deals has fallen from its peak in 2021, over a quarter of all venture capital funding in the 12 months leading to the third quarter of 2022 still went to climate-tech startups, a PwC report found. Over half of the VCs The Logic spoke to said they expect climate and social investments to grow.

“We will continue to be very bullish on climate solutions,” said Sandpiper Ventures co-founder and managing partner Rhiannon Davies. She said there will be more investments in the value chain that feed into the energy transition’s support infrastructure, such as technologies that help increase lithium mine yields for EV batteries.

She also said social impact will grow in importance.

“This is a really important time to be looking at inclusive investing,” Davies said. She said she thinks inclusive investing will continue to be a trend in the 2020s. “It’s been statistically proven that underrepresented founders will overperform. Women are very efficient in their use of capital, which is what we need to extend runways at this time.”

Lor agreed that there’s more to ESG than just green tech. He said that despite a decade of climate investment, our carbon footprint hasn’t been significantly reduced.

“One of the things that I think might be interesting is taking a look at ESG with a more defined and a wider lens, not just greenhouse-gas tracking, but taking a look at social impact … and if Canada is a good player on the social front,” he said.

From labour solutions and life sciences to proptech

Over 80 per cent of Canadian venture capital in the ICT sector went into software and services, the highest it’s been since at least 2013, according to the CVCA. Several VCs The Logic spoke to said software-as-a-service and the internet of things will remain hot.

Davies said she is specifically interested in how enterprise SaaS solutions can help improve labour efficiency to take some pressure off the tight job market: “Solutions that provide greater levels of efficiency [and] productivity are going to be key to what we’re looking at.”

HarbourVest managing director Senia Rapisarda said another way companies can unlock efficiencies—especially after facing issues related to supply-chain disruptions—is with the internet of things. “I’m very bullish on the industrial internet of things—anything that will make traditional industries efficient,” she said. “This is something that has happened during COVID and will continue to happen.”

Several VCs told The Logic they’re keeping an eye on the life-sciences industry. 

Davies said there’s interest in digital access to health care and looking for ways to enable better allocation of the health-care workforce.

CVCA CEO Kim Furlong also noted that life sciences don’t follow other economic trends. “People don’t stop being sick because economics are fluctuating. So life sciences, depending on the type of company, should also weather this differently than other verticals.”

Proptech will be another notable sector for 2023, given the effect of rising interest rates on Canadian real estate, according to Lor.

“Consumers obviously need a place to live,” he said. “They just need the Fed to basically come up and say, ‘OK, interest rates are stable,’ and then people can plan for it. So we have a bunch of fintechs in that area that are essentially helping people get into homes.”

He said he’s not just seeing opportunity in residential property; proptech specializing in commercial real estate will also be an important space to watch as companies are still trying to figure out whether employees should return to the office.

Valuations continue returning to Earth

After a year of “crazy prices” and “wild valuations” in 2021, VCs told The Logic that the softening market will bring both round sizes and valuations down further.

“There’s going to be some hurt in the cap tables,” said Rapisarda.

“There is a softening that’s going to occur, and I think that’s probably healthy for a normally functioning market,” said BDC Capital’s vice-president of operations and strategic initiatives, Chris Gillam.

Lor said the inflated valuations have “all gone away,” and Series A funding rounds and above have been falling, but that anything below those have continued to stay steady. 

Tran observed the same. “Some of the later-stage companies are being discounted between 30 to 60 per cent, but we haven’t seen that as much in seed and pre-seed,” she said.

Maple VC founder and general partner Andre Charoo gave another reason for the phenomenon.

“2023 is the year of survival,” he said. Many startups that fundraised in 2021 had a 24-month-plus cash runway and didn’t raise in 2022. “In 2023, they’re going to have 12 months or less of runway … which will likely drop valuations further because they’re going to be in a crunch for cash.”

Pendulum of power swinging towards VCs

Average deal sizes across the board have decreased by over 50 per cent in the third quarter of 2022, according to the CVCA. Investors generally agree that they’re going to have more negotiating power in the new year, but companies can still command deals if their fundamentals remain strong and are led by great founders.

“I think the pendulum has swung back to VCs, and we’ll be in a position to set the price,” said Charoo.

He said investors made exceptions for startups when the market was hot, but that’s no longer the case: “Those terms before were very flexible; they will become less flexible in the future.”

“We do have a little bit more negotiation power,” said Tran. “But I think we’re also cautious that great founders command [higher value].”

More time to date before committing

“Fundraising is taking longer as VCs are spending more time on due diligence,” OMERS Ventures partner Laura Lenz told The Logic via email. She said some might see this as a shift in the balance of power to investors, but it could also provide founders with more time to get to know potential VC partners before welcoming them to their board.

Charoo also sees this as an advantage for founders and investors.

“When you’re making a partnership, it’s like a marriage. It shouldn’t happen in 30 minutes or an hour or a day; it should happen over a period of time,” said Charoo. With a tighter environment, VCs will have more time to make decisions and understand the founders. “I think it will be well received on both sides,” he said.

With files from Catherine McIntyre