4 Foundational Elements for Investing Amidst High Interest Rates and Rapid Innovation

One of the perplexing aspects of VC today is that founders and investors are faced with rapid innovation within a restrictive monetary environment.

From investors’ perspectives, even if they are successful in finding and financing the right deal, how can they be sure the technology won’t be obsolete before it has time to mature and scale?

And finding the right projects to support is increasingly difficult. The high price of capital has shifted the risk curve and is driving a premium for deals perceived as being higher in quality (and therefore lower in risk). Looking at this recent report from KPMG, it’s clear that the global VC market was in distress in Q4 2023, with the deals falling to levels not seen since 2016. EY reports that the cumulative PE and VC investment declined in Q1 2024 to $13.5 billion, but the deal volume was up by 33% year over year.

So, while the deal count continued to decline, valuations for the startups that get deals are still climbing. This sets the table for a dynamic in which quality deals are highly sought after and increasingly valued, or even over-valued, as they attract a disproportionate share of a shrinking pool of capital.

While this is certainly a challenging environment, good deals are out there for both investors and startups. Below, I share the four proven elements I’ve used to vet winning technology investments for years.

1. Nail Your Niche

It’s vital for new technologies to dominate their wheelhouse use cases completely. The product being developed has a far better chance of success when it is the go-to option for a single scope rather than being a less compelling contender in a half-dozen use cases.

ID.me, my first angel investment that became a unicorn, is an excellent example of a startup completely owning its niche. Rather than chasing a broad market on day one, ID.me focused on a very narrow market: identity protection for the military community. This company grew from a seed to a $1.5 billion giant by holding fast to its original mission.

The founder, Blake Hall, is a third-generation military member and combat veteran. When he learned that veterans and their families were nearly twice as likely to fall victim to identity theft as the general population, he created an elegant solution called TroopSwap. Think of the initial product as a type of Groupon for the military that included built-in digital ID verification. It helped service members access exclusive discounts and benefits safely without exposing their personal information for exploitation by hackers or other bad actors.

While he realized from the start that everyone needs better digital identity protection and that there was an enormous untapped market, Blake stayed focused on the original use case and dominated the space. This specificity early on was vital to his later success, as it provided time and opportunity for the technology to grow vertically and built trust with government agencies and users.

Later, when the time was right, TroopSwap pivoted into a broader Identity-as-a-Service platform, now called ID.me, and truly soared. More than 125 million Americans use its digital wallet, and the company is a true unicorn valued at more than $1.5 billion and earning approximately $150 million in ARR.

Specialization is the key, and AI technologies are making it possible for companies to differentiate themselves by hyper-specializing in specific verticals and markets that are slowly embracing digital transformation.

Ohanafy, a recent addition to Cape Fear Ventures’s investment portfolio, has done an excellent job establishing itself as the premier AI platform for the beverage industry. The founder, Ian Padrick, and his leadership team created an innovative, purpose-built digital platform to drive revenue growth, reduce costs, and streamline operational efficiency and decision-making for producers, distributors, and importers at scale. It uses predictive analytics and AI to streamline processes and maximize efficiency, visibility, and profitability for the industry’s three main groups of stakeholders.

Ohanafy is years ahead of any other AI player that could enter the beverage vertical, and a competitive advantage of this magnitude enhances the “stickiness” of the technology — an informal measure of how difficult it would be for another emerging technology to displace the original innovation.

What is the key to ID.me and Ohanafy’s success stories? They didn’t try to boil the ocean. They both started by solving one problem better, faster, and/or cheaper than any other company could dream of doing it.

2. Mission and Leadership Matter

As an investor, I always look for an authentic fire in a founder’s belly.

Emotions are a huge factor in the success or failure of startups because the process of launching and scaling a business is incredibly hard and gut-wrenching. If a founder doesn’t have a solid emotional attachment to seeing the company succeed, they will eventually burn out. The headwinds are just too strong to persevere without a passion for what they’re trying to do.

There was no shortage of passion behind ID.me. Blake’s drive to help his fellow veterans, strong leadership skills, resilience, and ability to adapt and overcome adversity were integral to the company’s success. From the first time I met him, I was convinced that he believed in what he was doing and that his people were 100% bought into the mission and would walk through fire for him. I felt the same way when I first met Ian and the team at Ohanafy, which is why we led their seed raise.

A brilliant idea isn’t enough. Startups need an articulated mission that is understood and believed in by the leadership team and early hires from day one.

3. Early Backing Can Accelerate Outliers to Maximize Growth

VC done right is a relationship as much as an investment. As such, I focus on early-stage projects so I can invest in the seed or Series A phase. This is mutually beneficial for several reasons.

With more than 20 years of experience founding, leading, and investing in tech companies, I can offer an informed perspective to founders early in their journey—especially regarding the key initial tasks that can help build value and set up the company for massive growth.

Founders already have their hands full. I see myself as a partner who can take up some of the slack as the volume and complexity of scaling the business grows.

When passionate leaders with disruptive ideas are surrounded by experienced people who have successfully led companies from seed to commercialization, amazing things can happen. Never underestimate the power of believing in a founder’s vision before it’s obvious to everyone else.

4. Innovate and Adapt

Innovating and adapting isn’t a simple, one-and-done, two-step process. It’s more of a continuous loop. Even if you start with a massive idea that offers incredible value, in a market that’s moving and evolving this quickly, it’s critical for entrepreneurs and investors to continue adapting and innovating the product to maximize the project’s value and impact potential.

ID.me, for example, expanded its services after nailing its niche with military families. The company scaled its platform to provide identity verification services for a much broader audience with similar needs, such as healthcare providers and government agencies. SpaceX, on the other hand, took a less linear but perhaps more opportunistic approach to innovation and adaptation.

Early on, SpaceX focused on developing and proving the capabilities of the early Falcon rockets and Dragon spacecraft. While much of the early public interest in these projects was related to private space travel and space tourism, the company took a much more practical turn in securing its niche in space once the rockets were proven.

Based on the bold and ambitious idea of “rebuilding the internet in space,” as described by Elon Musk, the company pivoted to capitalizing on the commercial freight utility and cargo capacity of its rockets. Initially, SpaceX launched 60 operational Starlink satellites to provide reliable internet service to anyone, anywhere on the planet. The company has since launched a total of 5,977 satellites, generating $6.6 billion in projected revenues. Looking ahead, SpaceX plans to launch approximately 12,000 satellites in this phase and maintains an overall goal of up to 42,000 low-orbit satellites.

The company is also innovating new uses for its core technology and infrastructure outside Starlink, including Starshield (essentially, Starlink tailored for national security interests), the rocket cargo initiative, satellite launch services, and interstellar space travel. Each of these pursuits builds upon the core assets and capabilities that the company first developed.

By continually innovating and pushing the boundaries of the technologies being developed, SpaceX will be incredibly difficult to challenge in the coming years. Competitors will be years and billions of dollars of R&D behind them.

Where to Look for Opportunities

While 2023 and the first two quarters of 2024 have been tough for both founders looking to scale and investors looking for good opportunities, there are indications that some of the macroeconomic headwinds are beginning to subside. The outlook is better for AI projects and the emerging technologies that Cape Fear Ventures focuses on.

AI proved its commercial viability in 2023, and since then, as new use cases arise daily in every industry and vertical, the level of interest has been unprecedented. Regardless of what happens with interest rates, promising AI projects will continue to attract a disproportionate number of investors, which will, in turn, continue to rapidly drive up the valuation of these companies.

To maximize the potential of these technologies, it’s critical for investors to recognize the value potential of these companies in their given markets very early in their journey — and that’s where Cape Fear Ventures excels. We help to connect founders with promising early-stage AI projects to the right investors. Our goal is to maximize returns while preserving owner equity in the company.

Contact me through LinkedIn if you’re looking to deploy capital in disruptive AI projects, or if you’re a founder with a game-changing idea. We’re on the verge of an amazing period of technological innovation, and I’m always looking to connect with people who share my optimism for the future.

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