Investor Optimism Still Lags for VC in Q2

A Quarterly Wink and a Glance at Venture Capital   

VCs continued to be cautious in their investment strategy in Q2, even though the tech-heavy NASDAQ has increased more than 30% in 2023. VCs invested only $39.8 billion in Q2 2023, which was slightly below Q1 levels and 48% below Q2 2022. The capital invested in Q2 2023 represented the lowest quarter of VC dollars invested since Q4 2019. This lukewarm investment climate is occurring despite an uptick in the performance of public tech stocks and all the optimism surrounding artificial intelligence (“AI.”) VCs continue to take a pause in investing, and there is certainly now a philosophy in investing in the strongest companies exhibiting a clear path to growth, profitability and exit.

VC Market Shows Signs of Tightening

Technology companies in all sectors and stages are experiencing a much tighter capital market. Dollars invested, exit values and fundraising are all down significantly from the record years of 2020 and 2021. With the reality of a tightening market, VCs are advising their portfolio companies to conserve cash, while still attempting to increase revenues. This could eliminate the need for later rounds of fundraising. Everyone is concerned that valuations in future rounds will, at best, be flat but will probably be down. In fact, in Q2 2023, approximately 14% of completed deals are considered down rounds.

VCs Now Have the Leverage in Deal Negotiations

With capital being less available and more deal terms being dictated by the VCs, it certainly looks like the VCs are back in the driver’s seat. This is evident in the decrease in valuations at most stages. Median angel deal valuations were $4.4 million for the first half of 2023 compared to $4.9 million for 2022. Median seed-stage valuations were $10.9 million for the first half of 2023, which was up slightly from $10.5 million in 2022. Median valuations for early-stage deals in the first half of 2023 were $50 million, which was down 20% from 2022. Median valuations for late-stage deals in the first half of 2023 were also down more than 10% compared to median valuations in 2022. The median late-stage deal in the first half of 2023 was $55 million compared to $63 million in 2022.

Corporate VCs (“CVCs”) Still Active in VC Deals

CVCs are still active players in VC deals. In Q2 2023, CVCs invested in more than 24% of all venture deals. This level of activity was similar to participation rates in 2022. With valuations for early-stage startups on the decline, expect to see CVCs as more active investors, especially as these companies become more attractively priced.

Exit Events Still Way Behind

Through the first six months of 2023, there have only been 588 venture-backed exits totaling $12 billion. By comparison, there were almost 1,400 exits in 2022 totaling $76 billion. If things don’t improve quickly, 2023 will have the lowest number of exit events for the last decade. With the IPO market still somewhat dormant, acquisitions provided most exit values. For the first half of 2023, acquisitions accounted for more than 55% of the exit value. With valuations of startups trending downward, expect corporations to continue to be in acquisition mode and look for companies at a considerable discount.

Fundraising Hits a Roadblock

For the first half of 2023, fundraising by GPs totaled only $33 billion for 233 funds. This is quite a drop from the $167 billion that was raised across 1,095 funds in 2022. This year is shaping up to be the worst VC fundraising year since 2017, when only $46 billion was raised for 660 funds. GPs are seeing the negative result of low distributions to LPs due to the lack of exit activity, an uncertain world economic stage and perhaps an overallocation to the VC asset class during the COVID years.

Even though fundraising has taken a dip, it is estimated that there is approximately $280 billion of dry powder waiting to be invested, most of which is with VC funds greater than $500 million.

Outlook

Even though VC investment, exits and fundraising are all trending down, there are still many reasons to be optimistic, especially with all the buzz surrounding innovation in AI and life sciences. Public tech stocks are beginning to recover in 2023, so hopefully the VC space will not be that far behind. It will also be interesting to see if the IPO market opens up again. No one can argue that the VC market is tightening, but there is still considerable dry powder waiting to find a home. VCs will continue to support innovators and disruptive startups that can prove they can scale profitably. It will be interesting to see if VC recovers during the second half of 2023. We’ll see.