Is tech innovation being stalled by higher interest rates?

With interest rates remaining elevated and uncertainty surrounding the Federal Reserve's next steps in its monetary policy, Techstars CEO Maëlle Gavet joins Yahoo Finance to share her perspective on how higher rates are hampering tech innovation.

Gavet notes that higher interest rates "limit the ability for venture capital firms to raise funds," which consequently reduces their capacity to invest in innovative startups. This environment, in turn, makes it increasingly difficult for startups to grow their businesses, creating a continued cycle.

Gavet points out that due to persistently high inflation numbers, it becomes challenging for the Fed to cut rates. Although markets (^DJI, ^IXIC, ^GSPC) are hoping to see an interest rate cut sometime in 2024, she states that she is "not seeing a fundamental change" in inflation that instills confidence in the Fed's willingness to pursue such a move.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance.

This post was written by Angel Smith

Video transcript

SEANA SMITH: Interest rates seem to be higher for longer, and global venture capital investments have fallen to a five-year low in the first three months of this year. Now, this is according to the latest data that we're getting out from PitchBook. Well, our next guest warns that higher rates are stifling tech innovation.

Joining us now is Maelle Gavet, a CEO of Techstars. It's a pre-seed investor company here with a direct line of insight into seeing how early stage tech companies are raising cash. Maelle, it's great to chat with you here. So talk to me just about what you are seeing, the interest that you are seeing from some of these smaller tech names, and exactly the challenge that higher rates pose here at this point in the economic cycle.

MAELLE GAVET: Absolutely. Happy Monday. Thanks for having me. So when we think about the high interest rate, I think the first direct impact it has on tech innovation is that it limits the ability for venture capital firms to raise funds and then invest those funds into innovative startups. And that, in turn, reduces the availability of capital startups have to build and grow their businesses. And so that becomes a lot harder in general for tech innovation to appear. That would be the prime driver.

MADISSON MILLS: So where are we at in this cycle, Maelle. I'm curious. Obviously, when we're in a zero-interest rate environment, that is amazing because we've got a bunch of cash sloshing around. Then that went, and we saw a big slowdown. And we're making our way out of that. Is the slowdown totally in the rear view from your point of view?

MAELLE GAVET: So if you're asking me my forecast for the interest rates, my crystal ball doesn't always work perfectly. I would say, look, the Fed is likely going to try to cut the interest rate because of the election pressure. It happens every time. But because the inflation numbers are so high, 3 and 1/2% last month and going up from the month before, it is too early for them to do so.

And when we're having conversation we with LPs, we keep hearing that, which is, interest rates are high. For the LPs who have multiasset class strategy, they compare the VC asset class with others. And then they start saying that they may find fixed income or other asset class more attractive in this high interest rate environment. And so as of today, I am not seeing a fundamental change even though everybody is hoping that there is going to be an interest rate cut with the election coming.

SEANA SMITH: Maelle, you put in your notes here that 2024 is going to be the year here of the great adventure reset. So talk to me just about that. And then when you talk about the fact that we have this higher for longer rate environment right now, what is that going to do just in terms of competition within the VC space? And ultimately, you would think increased consolidation potentially at one point.

MAELLE GAVET: So I think when it comes to the VC environment, we're already seeing mostly in the back rooms, but very much there the consolidation at play. You see more and more VCs having a really hard time to raise and moving into what we call the zombie mode, which is when a VC is still active because they're still managing their previous funds, but they can't raise a new fund.

And so they're basically step by step closing shop, but they don't have to say so publicly. Again, the fundraising has been pretty difficult in 2023. The US venture capital firms raised about $67 billion. That was the lowest annual total since 2017. And that was a 60% drop versus 2022. So it's a pretty substantial changes, and I do expect some further consolidation there.