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In education, we know that focused, personalized approaches work. We see the impact on everything from academic and career support to faculty training. Yet many investors continue to prioritize large-scale, one-size-fits-all EdTech solutions.
The traditional approach to venture capital in education is due for a shake-up. The timing is right as the education market starts to rebound. From 2022 to 2023, investments dropped two-thirds, falling to the lowest levels of funding since before 2018. Now, funding activity is poised to pick back up. As it does, pursuing a new investment strategy — one focused on how specific products serve the needs of individual institutions, classrooms, and learners — will give investors an edge.
Putting Venture Back into Venture Capital
Underpinning the current strategy of only backing companies with large total addressable markets (TAM) is understandable. EdTech with broad appeal feels like a safe bet. Tools that could work for everyone have the potential to be used by everyone. Plus, educators often purchase products with proven efficacy that will last for years.
The unicorn bias is also at play. Since Aileen Lee dropped the term into the collective lexicon in 2013, investors have been chasing the next billion-dollar valuation. To reach large returns, there is an assumption that a portfolio company has to cast a wide net. Yet, EdTech unicorns are as elusive as their namesakes — only 13 current companies have met the requisite milestone.
The fascination with sure bets and big exits has diminished interest in risk, especially for larger, more established firms. In prior years, some of that risk tolerance was absorbed by smaller venture funds that would place smaller bets on a wider number of startups. However, 38% of those funds disappeared in 2023, which has made it difficult for riskier EdTech startups to get lead investors for their pre-seed or seed rounds. There is reason for optimism as the amount of dry powder sitting on the sidelines is over $300 billion. However, well over half of that is concentrated in funds with over $500 million of commitments. The time is coming for these funds to allocate part of those resources to invest in long-term, scalable solutions. We are seeing early signs of this turnaround as deal sizes and valuations for seed stage investment continue to grow in the face of general headwinds in the venture market.
Redefining Returns in Education
Seeing the value in niche EdTech will require investors to examine their expectations about returns. Education investing should be about long-term scalable solutions, not short-term growth at all costs, a view that goes against the grain of traditional investing strategies.
Taking the long view works in education. EdTech built for a specific audience is more likely to serve their specific need, which will appeal to decision-makers within various educational organizations. The caveat is that these companies still have to have strong business fundamentals to make the case that they are a safe bet to EdTech buyers. This will become increasingly important as COVID-era federal funding ends later in 2024. Confidence in the company delivering the solution is potentially more valuable than the solution itself.
Investors have taken a similar view in recent years. EdTech startups need to be aware of this and manage their businesses accordingly. Investors must also do their part by rewarding startups with strong fundamentals with capital, even if the return on that capital may trail other industries. Quality EdTech investments can translate into stability for investors, which can sometimes mean even bigger returns in the long run than short-term sprints.
Niche Investment Strategy in Action
Our Accelerator client, Nucleos — whose platform provides secure access to higher education in prisons — is a great example of a niche approach to EdTech investment. Nucleos has a relatively small total addressable market. There are about 1.2 million incarcerated adults at 1,161 confinement facilities in the U.S. Comparatively, there are 19 million students enrolled in colleges and universities in the country. The potential impact of Nucleos’ offering, however, is sizeable. Earning an education can be transformative for people who are incarcerated and their communities, including lowering rates of recidivism and increasing employment and earning potential.
Traditional education investors might overlook a company like Nucleos. That oversight is costly not only to learners who benefit from the product but also to investors who will miss the chance to reach untapped areas of growth. By incorporating a "think small" approach into their overall portfolio strategy — focusing on the specific products, their target users, and the conditions under which they succeed — investors can build a more robust education market. This approach leads to stable, long-term returns.
