Q3 2024 Venture Financing Report – Interview With Asad Khaliq

Key insights from Asad Khaliq

On the most exciting advancements in technology right now: “Cybersecurity is unique in that progress is driven not just by technological improvements, but also by threat actors … Another area we are very excited about is edge computing.”

On trends in market terms: “Venture deals have generally trended towards some degree of standardization over the past few years. That makes sense because the industry is maturing, and therefore best practices have become clearer. As capital availability has increased, many founders also find themselves with lots of options for capital, and some terms that may have previously been more common have fallen out of favor.”

On key advice to succeed in VC investing: “The venture and startup ecosystem can be noisy, and there are a lot of ups and downs. You have to, of course, keep updating your priors and learning from what’s happening around you. But balance that with conviction and execution on your chosen strategy. I think most new venture advisors don’t appreciate how quickly your ideas and networks compound in the industry.”

What advancements in technology – particularly, in the realm of machine learning – are you most excited about right now, and how do you see these developments shaping the future of venture capital?

We have been investing in founders leveraging machine learning (ML) for many years. It used to be the case that to successfully utilize ML you’d need meaningful team resources, relatively large volumes of data, and a significant amount of time to train, test and deploy models. Of course, foundation models shorten that period – in some cases, to hours or minutes – and in many instances, the output is even higher quality. One area we invest a lot in is cybersecurity. Cybersecurity is unique in that progress is driven not just by technological improvements, but also by threat actors. The power and speed of foundation models is available to threat actors, too. And there is an interesting dynamic today where threat actors only need this powerful new technology to be directionally useful – in other words, they only need for their artificial intelligence-powered attacks to work some of the time to still be very successful. On the other hand, if you’re a cybersecurity entrepreneur or enterprise adopting a new security solution, you want to be sure it’ll work more like 95 – 100% of the time. So the bar is much higher for defenders than it is for attackers. The best founders are drawn to that challenge, and, of course, customers are actively looking to shore up their defenses. We co-led the seed round in a business called Protect AI, one of the leaders in the AI security category, and we’re continuing to back founders working to build security solutions as the threat environment changes rapidly. Another area we are very excited about is edge computing. Of course, we’re all familiar with the huge amount of graphic processing unit (GPU) and cloud data center investment going into training models. Equally important, we think, is inference – the compute power that’s needed when users actually use or query the models. If this happens in the cloud, a bunch of latency and potential reliability issues are introduced while your query gets sent to the cloud and back to your device. Instead, we think a lot of this processing will happen at the edge. Companies like Apple have already started pushing hardware and software evolutions to make this happen. And we’re investors in two – Edge Impulse (which makes it easy for developers to run ML at the edge, including on tiny microcontrollers) and Ditto (which provides an edge database and connectivity platform to allow devices, such as phones and laptops, to communicate without needing an internet connection).

How does Acrew leverage its interdisciplinary collaboration and deep networks to stay ahead in the rapidly evolving technology landscape? Can you share examples of how this approach has helped you identify emerging trends and drive innovative solutions?

We operate as one firm that houses specialist practices in three areas: data and security, fintech, and health. A lot of what we do fits squarely into one of those areas, but many of our investments end up sitting at the intersection of two or even all three of those areas. Our approach provides the depth of a specialist firm in each sector, while also providing the benefits of cross-sector insights and networks given how closely we collaborate. We led one of the early-stage rounds in At-Bay, an insurance and security platform that tackles cyber risk for small to medium-sized businesses. At the time of our investment, cyber insurance was viewed as a challenging category. Given the time we spend in both fintech and data and security, we were struck by the ambition and domain depth of founders Rotem Iram and Roman Itskovich. The company had a unique insight, which was that the winning cyber insurance provider would be both a fintech company (with best-in-class insurance products and risk management) and a data and security company (with a product suite that actually improves the security posture of its clients). At-Bay has since had meaningful growth and impact on the industry. We believe in operating like one team. Founders get access to all of our investors, not just the ones they work with day to day. And our combination of specialist depth and collaboration is also useful to our founders. For instance, many of our founders, regardless of their sector focus, appreciate our cybersecurity expertise. Conversely, many of our cybersecurity founders find ideal early customers in our fintech and health networks. That’s really energizing to us.

As a longtime (note: I just stepped off the board) board member of NextGen Partners, which supports aspiring venture investors, what key pieces of advice do you typically share about succeeding in venture capital investing?

Venture capital investing is a really broad term. A sector-focused seed fund has to think about a totally different set of operational criteria than a large platform firm with multiple funds and strategies. If you’re new to the industry, it’s hard to fully appreciate and understand those differences. I always encourage people to take the time to understand where there’s value and where there might be inefficiencies in the way that different investors and firms operate. Once you have a sense of that, it’s really important to think about what game you want to play and what you’re drawn to – and suited to – doing. Over time, you’ll find out where your edge lies relative to your peers and counterparts. Once you find it and build conviction in it, you have to execute in a patient and disciplined way. The venture and startup ecosystem can be noisy, and there are a lot of ups and downs. You have to, of course, keep updating your priors and learning from what’s happening around you. But balance that with conviction and execution on your chosen strategy. I think most new venture advisors don’t appreciate how quickly your ideas and networks compound in the industry. I feel very grateful to have worked with so many wonderful and trusted founders and co-investors at this point. All those relationships compound and build on each other and come back to you in incredibly positive ways. Time is a powerful ingredient.

Given the recent trends highlighted in our Q3 2024 report, where we saw a decrease in deal volume for tech company venture financings but a significant increase in both invested capital and average deal size, what key drivers do you believe are contributing to this trend?

A lot of investing activity right now is in or around AI and ML tailwinds. I think there’s a prevailing, and in some cases warranted, belief that larger players in AI can accrue an unassailable advantage as they scale. In some cases, this is because the technology to do something well has effectively commoditized, so the primary determinant of success becomes distribution and compounding scale. In some cases, it’s because of the cost and quantity of data required to train or improve models. There’s also a lot of investment going into first-movers in various spaces that are seeing AI-driven transformation, and a large amount of capital could conceivably help cement that first-mover advantage. Capital can be a short term moat, but companies will have to use it well to invest in more robust and defensible moats over the medium to long term. In certain sectors, I wouldn’t be surprised to see this dynamic shift once again to more diffused capital allocation. Of course there are structural forces at play as well. Venture fund sizes have grown considerably in the past decade or so, so there’s more capital available to be deployed. Larger funds also need larger outcomes in order to successfully generate returns, which places upward pressure on how much capital firms need to put to work. I think you’re also seeing other ecosystem players get creative – large hardware and compute providers like NVIDIA, Google and Microsoft, for instance, are participating meaningfully in venture rounds and often with creative mechanics, like cloud or GPU credits.

In Q3 2024, we saw that 96% of deals included both a one-time liquidation preference and nonparticipating preferred stock, while 100% featured broad-based weighted average anti-dilution protection. This marks a significant shift with no deals including full-ratchet, anti-dilution protection. What do you believe is driving these specific terms, and how do you see these trends shaping investor preferences or company valuations moving forward?

Venture deals have generally trended towards some degree of standardization over the past few years. That makes sense because the industry is maturing, and therefore best practices have become clearer. As capital availability has increased, many founders also find themselves with lots of options for capital, and some terms that may have previously been more common have fallen out of favor. It’s no secret that valuations in AI and ML are comparatively high at the moment. For those that emerge as big winners of this cycle, they’ll feel like a bargain in retrospect.

Are there any additional insights on market trends or noteworthy observations from this quarter’s VC data that you’d like to highlight?

The mid-to-growth-stage venture market has been in flux over the past couple of years. The data seem to indicate a positive shift in investor expectations at the Series B to Series D rounds, in the form of either (or both) valuations and round sizes. To me, that suggests that expectations for large-scale M&A, as well as the potential opening of the initial public offering (IPO) window, are warming.

About Asad Khaliq

As a co-founder and general partner at Acrew Capital, Asad invests primarily in cybersecurity and data businesses. He has led investments in Ditto, System, Edge Impulse, Vanta, Aira, Bazaar and Arthur AI, among others. He studied management science and engineering at Stanford University.

About Acrew Capital

Acrew Capital is a multigenerational partnership with a track record of supporting enduring companies. The firm distinguishes itself by means of a values orientation, thesis focus and a highly differentiated executive network of more than 600 executives and operators. The firm invests out of an early-stage, as well as a growth-stage, fund focused on companies in fintech, data and security, and health.