With continued uncertainty in the macro environment, both investors and founders have plenty to think about when charting their course in the near- to medium-term, explains SV Ventures CEO Erik Arnetz.
Times like these prompt a fair amount of preaching and prognosticating about what to expect. As a result, several different narratives have emerged about what’s driving current market dynamics. While it’s tempting for investors to latch onto some of these narratives as “conventional wisdom”, it’s also important to look carefully at what the numbers actually say about the attractiveness of AI, the need for profits, and where the market is headed. Just because a lot of people are saying one thing or another, doesn’t make it true.
It’s all about AI - or is it?
Take all the hype around AI, for example. It’s been clear for months that AI is having a moment, both globally and in Sweden. The number of articles in the Swedish press mentioning AI is already twice as high as the total for all of 2022. And AI mentions in S&P 500 analyst calls hit an all-time high in Q2 2023. All the hype can easily lead one to conclude that AI is the only sector attracting investment in today’s market. But a closer look reveals that many of the AI deals getting media attention are relatively small.
When looking at larger tech deals (at least 10m SEK), we see a different story, however. While AI companies raised a respectable 602m SEK through seven large transactions in the first eight months of 2023, this only represents about 6 percent of deal volume and 2 percent of the capital raised in Sweden so far this year.
A sector-by-sector breakdown of transactions through August 31, 2023, shows that green tech is the biggest sector both in terms of number of deals (26) and capital raised (19.2bn SEK). Granted, the lion’s share of that figure is attributable to Northvolt, which alone raised a whopping 17.3bn. Even correcting for the Nothvolt effect, other green techs together attracted more than three times as much capital as AI startups.
Fintech has also outperformed AI in terms of deal volume (16) and capital raised (2.3bn SEK) so far in 2023, demonstrating further that AI is not nearly as dominant as the headlines and hype might suggest.
Rather than being an increasingly powerful magnet for new investment in 2023, it seems AI is more or less on pace to match investment levels in 2022, when 10 companies raised just over 1bn SEK in large deals. It seems all the talk about AI is just that – talk.
Upon closer inspection, much of the buzz stems from companies talking about how they plan to incorporate AI and automation into their operations rather than positioning themselves as true AI-first companies. Thus, there’s no evidence to suggest AI startups in Sweden are attracting any more capital than they were previously.
Profitability: need to have or nice to have?
The supposed dominance of AI isn’t the only misleading narrative making the rounds in the Swedish private capital markets these days. It’s also increasingly common to hear that, in today's tougher economic climate, investors are only interested in companies that are profitable.
There’s lots of talk about a necessary “pivot to profitability” for startups hoping to raise fresh capital. It’s certainly true that investors are shying away from companies looking to ramp up expenses in the near- to medium-term. Capital is more expensive and there’s simply very little appetite for funding loss-making businesses that lack solid unit economics.
But is profitability really a prerequisite for attracting growth capital in Sweden in 2023?
A quick look at the numbers gives a clear answer: no.
Looking at the data on capital raises so far this year, at least 84 percent of companies that attracted at least 10m SEK in capital weren’t profitable. Of 117 deals in our analysis, only 11 involved profitable companies. Moreover, the figures for 2023 are largely in line with those of 2022 - in other words, unprofitable companies are just as successful at raising capital in 2023 as they were in 2022.
So, it’s alarming that, out of the numerous companies we’ve met with so far this year, the majority tell us they’re worried they won’t be able to raise money simply because they’re not profitable.
What investors are looking for isn’t profitability, per se, but rather healthy unit economics, gross margins, and other fundamentals indicating new businesses are on a clear path to profitability.
Loss-making entrepreneurs with promising metrics shouldn’t let this “profitability myth” prevent them from seeking new capital. Investors are certainly willing to invest in unprofitable companies. However, companies touting valuations that are disconnected from a business’s fundamentals won’t likely get much traction.
Aggressive valuations simply won’t fly in the current investment climate. Rather than unicorn dreams and fairytale valuations, founders need to tell credible, no-nonsense stories about what makes their companies compelling and why their valuations are justified.
Private market investments in Sweden: turning the corner
And what more can be said of the current investment climate in Sweden? While it may be premature to forecast smooth sailing ahead, there is plenty to be optimistic about. Lots of fresh capital from the private markets is being put to work in Sweden, even if the demands for raising money have changed. It’s true that first-time funds face a steeper hill compared to funds with established track records. Some companies that lack a solid proof of concept are also now having a harder time raising money than they did in the previous bull market.
But don’t believe the hype. A lot of deals are still happening across a range of sectors, with the number of deals in 2023 looking to be roughly in line with 2022. Sure, the rounds might be smaller, and the valuations might be lower, but the data so far this year suggests we’re arriving at some sort of equilibrium in the market for Swedish growth investments.
Rather than the boom-bust cycle of the early 2000s, the Swedish private capital market appears increasingly non-cyclical and well on its way to becoming a stable sector of the economy capable of supporting around 200+ deals annually.
Swedish growth investment is here to stay, and conditions aren't worse; rather the focus has shifted to a smaller number of subsectors and investors are pivoting their focus to slightly more proven bets.
Erik Arnetz
CEO & Founding Partner