August 1, 2023

The Impact of the Technology Cycle on Venture Funding

The technology cycle refers to technology creation, adoption, maturity, and replacement. The technology cycle, also known as the innovation cycle, refers to the phases a new technology goes through, from inception to widespread adoption and eventual obsolescence. It typically comprises stages such as innovation, syndication, diffusion, and substitution or decline.

Innovation. This is when a new technology is developed. During this stage, it’s used mainly by innovators or early adopters excited about the potential of new technology. High costs and high risks characterize this stage, but also high potential rewards.
Syndication. In this stage, the technology becomes more standardized and begins to be used by the early majority of users. The technology is more widely available, but there’s still room for significant growth.
Diffusion. The technology is now used by the late majority. It’s widely accepted and used, and there are fewer growth opportunities.
Substitution or Decline. The technology begins to be replaced by newer technologies. It’s used only by laggards, and there are limited growth opportunities.

Savvy VCs think of the combined impact of the technology cycle and disruption in the market that technology is catalyzing

Tech startups are especially sensitive to this cycle and how quickly it takes place. Startups founded during technology’s creation or early adoption phase can achieve exponential growth as the technology matures and becomes widely adopted. Savvy VCs think of the combined impact of the technology cycle and disruption in the market that technology is catalyzing. Focusing on technology without considering its impact on the market will likely lead to wrong investment decisions. Technology changes very quickly, making what’s important today of very little value tomorrow, pushing down the value chain. For example, at the time of this writing, the hype around AI is creating a FOMO effect, and VCs are rushing to invest in companies that built AI models or relevant tools, which got displaced very quickly with community-led OSS tools; and many startups very quickly becoming a weak business potential.

High-Tech Startups can be pushed won the value chain and become the living dead very quickly.

For early-stage startups, understanding the technology cycle is critical because the success of their product or service often depends on where it falls within this cycle. If they’re too early in the cycle, they may face challenges with user adoption or high development costs. If they’re too late, they may face stiff competition or find the market saturated.

Impact of Technology Cycles on Venture Funds

Now, for venture capitalists, the technology cycle can also impact their ability to raise and invest funds. As much as VCs feel the hype and FOMO investing in startups, LPs feel the same. They don’t want to miss investing in hot technology, as well as they don’t want to appear as the dump investors who are investing in a losing section. Therefore, you need to be aware that the technology cycle can affect your fund cycle in these ways.

As much as VCs feel the hype and FOMO investing in startups, LPs feel the same.

Fundraising. When a new technology is in the innovation or syndication stage, there’s a lot of excitement and potential for high returns, which can attract LPs, as what’s happening with AI at the time of this writing. However, this stage also comes with high risk, which some LPs may be wary of. The risk may be lower in the diffusion or substitution stage, but so is the potential for outsized returns.

Investing. VCs want to invest in startups in the early stages of the technology cycle, with the highest growth potential. However, they also need to consider the risk that the technology may not achieve widespread adoption or that the startup may be unable to outcompete others in the same space.

Exit Opportunities. The stage of the technology cycle also impacts exit opportunities. If the technology is nearing the end of its cycle by the time the startup is ready to exit, it may be more challenging to find a buyer or go public.

Timing Great Investments with Technology Cycle

Investments in emerging technologies can offer high returns if the technology becomes mainstream, but they also carry significant risks if the technology fails to gain widespread acceptance. As such, VCs need to ask the right questions when considering investments in different stages of the technology cycle:

Where is the technology in its cycle? Understanding the stage of the technology cycle can help assess the risk and potential return of the investment. If the technology is in its early stages, it might offer high return potential, but the risk is also higher.

Does the startup have a unique or proprietary advantage in the technology? If the startup has unique knowledge, patents, or other advantages, it could have an edge over competitors and be better positioned to succeed.

Where does the technology set in the value chain? Money moves from the top to the bottom of the value chain.

What is the potential value of the technology in the market? Even if the technology is groundbreaking, the investment might yield low returns if it cannot extract a good value from its customers, given that it provides great value to customers.

How quickly is the technology being adopted? Rapid adoption might indicate that the technology is moving towards the diffusion stage of the cycle, which could offer significant growth potential.

What is the competitive landscape? If many startups are in the same space, it could signal that the technology is in the syndication or diffusion stage. The startup will need to have a clear competitive advantage to succeed.

What is the startup’s plan for scaling? Understanding how the startup plans to scale can give insight into how well it’ll capitalize on the technology’s growth.

How experienced is the team in this technology sector? A team with experience in the technology sector will be better able to navigate the challenges and opportunities of the technology cycle.

Is there a regulatory risk? Some technologies (like health tech or fintech) may face regulatory risks that could impact their growth.

Is the startup’s technology flexible and adaptable? The ability to pivot or adapt technology can be crucial, particularly if a new, competing technology enters the market.

Closing Remarks

To navigate the technology cycle, stay informed about technological trends and assess where a technology is in its cycle today and where it’s likely to be. Adept at risk management, balancing the high-reward opportunities in the early stages of the cycle with the lower-risk ones in the later stages.

This article ends my series on the impact of market cycles on venture funding. I hope you find these articles useful. Please leave your comments or questions. I’d love to hear your thoughts!