A third-quarter downturn in venture capital (VC) dollars raised in the United States, particularly in later-stage deals and from nontraditional investors like asset managers, is the first evidence of distress in the VC ecosystem.
The value of VC deals for the first three quarters of 2022 was still historically high at $194.9 billion, according to the Pitchbook-NVCA Venture Monitor, from Pitchbook and the National Venture Capital Association. (See chart.) But last quarter saw a dip to $43 billion invested from $62.3 billion in the second quarter. That's a nine-quarter low, according to Pitchbook-NVCA. That cemented "a tone of investor hesitancy and increased focus on business fundamentals amid the global economic downturn," according to the report accompanying the data.
Deal counts dropped nearly 20% from the quarterly high in Q1 2022, per the report. The fall in value and activity is in part due to lower participation from private equity firms and asset managers across funding stages. PE firms, for example, participated in 48% of deal value this year, compared with 59% in 2021.
Early-stage VC activity (not charted) trended downward for the third straight quarter, to $13.5 billion.
"The continued public market volatility has weakened capital deployment in early-stage deals as investors become more apprehensive about the large, outlier-sized deals of the past couple of years," according to Pitchbook-NVCA. "Investors are focusing on investing in the fundamentals of a startup instead of relying on another VC firm to invest at an even higher valuation."
Anton Levy, chair of the global technology group at General Atlantic, said there is now much more of a focus on ROI. Speaking at the Forbes Iconoclast event on November 3, Levy said at peak activity the mentality of "growth at all costs" at high-growth firms was being rewarded by the marketplace and investors were "just looking at revenue multiples."
Another cause for the slowdown in the third quarter was lower median deal size, as "startup founders may be opting to raise smaller amounts of capital in an effort preserve equity and to bridge the gap until the market resumes its strength."
"Ballooning" Beyond Capacity
Total dollars in late-stage VC deals also fell in the third quarter, to $24.9 billion, down 48% from the second quarter, although the year-to-date total for 2022 was near record-setting. (See chart).
The surplus of capital the past two years led startups to "blitzscale" — "balloon beyond their capacity to generate positive free cash flow and loosen their dependence on investor capital," according to the Pitchbook-NVCA report.
With valuations in public markets dropping, VCs may have to start marking down their portfolio companies. But they are hesitant to do so. It could affect their ability to attract new fund commitments and their portfolio companies' ability to raise subsequent financing. But markdowns have begun to happen — T. Rowe Price, for example, has written down its investment in unicorn startup Canva by 44% since the end of 2021.
Experts expect "down rounds" — startups raising funds at lower valuations — to increase in the months ahead.
Affecting the entire supply chain of VC money is the lethargic market for VC-backed exits.
Just $14 billion in exit value was generated in the third quarter. "This year’s total exit value is in danger of falling below $100 billion for the first time since 2016," according to the Pitchbook-NVCA report.
Only 59 public market listings from VC-backed companies have occurred so far this year, one year after 303 VC-backed public listings generated $670 billion in exit value, said the report. In addition, only three SPACs listed last quarter, down from the peak of 281 listings in the first quarter of 2021. Many existing SPACs are finding a tough time finding targets as their two-year deadline to deploy capital nears.
The inability to IPO is particularly problematic for unicorns, whose exit path has been the public market "as few corporations are able and willing to buy such highly valued targets."
But all VC-backed startups that will eventually need to return to equity markets at lower valuations face strong headwinds, and their current shareholders will experience severe dilution, according to Pitchbook-NVCA.