With news out of the United States that the Federal Reserve is finally setting a course for lower interest rates, it’s a good time to take stock of the state of the famously interest-rate-sensitive startup economy.
But that’s a big, broad economy. So, let’s drill down a little deeper and take a look at the venture capital sector, specifically. Experienced VC firms like Target Global have weathered the past few years well; will they be joined by a wave of upstart firms or continue to play in a fairly quiet sandbox? How will interest rates and other market-moving economic factors influence activity? Will new, unexpected innovations help move capital off the sidelines?
We don’t have a crystal ball, of course, but let’s try our best to understand what’s driving the venture capital sector right now, and how that might change in 2025 and beyond.
1. Falling Interest Rates
For companies that need funding and funders that rely on financial leverage, the Federal Reserve’s decision to reduce interest rates was a huge deal. Overnight, it lowered the so-called “cost of capital” by 0.50%, which is quite a lot when your margins are measured in tenths of a percentage point.
Interest rates are expected to keep falling through 2025, so this tailwind will continue for some time longer. The entire venture capital sector, and those reliant on it, will benefit.
2. Signs of Life in the IPO Market
High interest rates have also held back the market for initial public offerings. Other factors, including general concerns about the state of the economy, have played a role too. This pattern could finally break in 2025, allowing venture capital firms to “exit” older investments and freeing up money to invest in new startups. Needless to say, this will benefit not only the investors but the companies and entrepreneurs they support.
3. Continued AI Breakthroughs
The “hype cycle” around new AI model releases is not what it was in 2022 and 2023. Rest assured, those releases are still happening, and they’re more impressive than ever. Some experts believe OpenAI’s GPT 4o shows flickers of reasoning ability, perhaps foreshadowing early examples of artificial general intelligence. Seasoned tech investors are keeping a close watch on the space and will surely identify breakthrough opportunities before the rest of us.
4. Improvements in Battery Chemistry and Cost
The growth of the electric vehicle market has helped drive down costs and increase efficiencies of rechargeable batteries. These improvements are iterative but steady.
They are also more meaningful than many non-experts realize because they enable cost-effective deployment of carbon-free electricity as well as new forms of mobility like electric vertical takeoff and landing aircraft (eVTOLs), which some believe represent the future of intra-urban transportation. Both sectors — carbon-free energy and electric mobility — are in high favor with VCs right now, and will continue to be in 2025 and beyond.
5. Changes in the U.S. Regulatory Apparatus
Another under-discussed trend that venture capital firms are watching closely is the shifting sands of federal regulation in the United States, the most important market for many technology solutions. These changes quite literally require a law degree to understand, but the upshot is that some sectors (such as AI) may have a freer hand to innovate in the future.
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Final Thoughts
These five factors are widely expected to influence venture capital activity in 2025. But they won’t stop there. With the possible exception of falling interest rates, these are emerging, longer-term trends that will have “legs” measured in years or even decades. The AI story, for example, is only just beginning, while the effects of recent changes in the U.S. regulatory state will most likely take years to become apparent in the real world.
In other words, we’re in for a long, wild ride. Better strap in.
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