Several simultaneously occurring economic, geopolitical and global health issues are finally having an adverse impact on the venture capital (“VC”) sector. It is no surprise that the slowdown in VC deal activity and fundraising is directly tied to a multifaceted global situation that still includes COVID-19 issues, continuing conflict between Ukraine and Russia, increasing interest rates, Silicon Valley and Signature Bank failures, and now the possible uncertainty surrounding the availability of venture debt or its equivalent. In Q1 2023, VC deal activity declined at all stages, while fundraising came to a dramatic halt. After raising a record-setting $163 billion in new capital in 2022, Q1 2023 fundraising amounted to a paltry $11.7 billion.

Early-Stage Venture Showing Some Cracks

In Q1 2023, only $9.6 billion was invested in early-stage deals, and the quarter represented the lowest quarterly deal volume since Q2 2020. We have now experienced six consecutive quarters of declining early- stage deal activity. Not only are deal numbers declining, but also median deal sizes are also on the decline. The median early-stage investment in Q1 was $6.2 million, which was quite a drop from the full-year median investment of $8.8 million in 2022. Median pre-money valuations for early-stage companies are also down. Q1 2023 median early-stage valuation was almost $40 million, which compares to full-year 2022 median valuation of $50 million.

Angel and Seed-Stage Deal Activity Was Resilient … Until Q1 2023

Angel and seed-stage deal activity avoided the issues associated with market volatility until Q1 2023. In Q1, angel and seed-stage deal activity only totaled $3.3 billion over 1,396 deals, which represented a more than 50% decrease from Q1 2022. Investors are much more selective in the angel and seed-stage deals in which they invest, and this is reflected in pre-money valuations. The median pre-money valuation for a seed-stage deal in Q1 2023 was $13 million—higher than the $10.5 million valuation for the full year 2022. The median pre-money valuation for angel deals was approximately $4 million, which was down about 18% from 2022.

Later Stage VC-Backed Companies Most Vulnerable to Declining Public Markets

In Q1 2023, only $11.6 billion was invested in late-stage deals. This represents seven consecutive quarters of decline, and it was also the first time that quarterly deal value was below $12 billion since Q4 2017. Q1 also had only 19 mega rounds, which compares quite unfavorably to 98 mega round deals achieved in Q1 2022.  The continued lack of exit activity, including the slowdown in the IPO market, has caused a significant problem for funds looking for substantial returns and LPs looking for liquidity. Funds are becoming leery of tying up more capital in companies where the timing of an exit can be difficult to predict.

Q1 2023 Exit Value at Lowest Point Since 2013

Q1 2023 only realized 227 exits at a total value of about $5.8 billion. Comparatively, in 2021, there were 1,951 exits totaling almost $770 billion. VC-backed companies near the end of the venture life cycle are continuing to experience difficulty due to a market not ready to support companies going public and VCs reluctant to continue to capitalize later stage companies.

Fundraising Becoming More Difficult

The ease of raising new funds in 2021 has certainly abated. In Q1 2023, VCs only raised $11.7 billion across 99 funds. Larger, more established funds are having an easier time raising capital. In Q1, more than 60% of the capital raised was committed to eight funds, and approximately 86% of the funds were raised by established fund managers. In fact, in Q1, emerging fund managers raised only $1.6 billion. Even though fundraising is way down, there is still almost $300 billion of dry powder sitting on the sidelines waiting to be invested. As such, there is hope that future VC activity could still be robust.

Outlook

There appears much uncertainty around the direction of the VC markets. Deal values, valuations and fundraising are all trending down. This was all occurring even before the collapse of Silicon Valley Bank and Signature Bank in March 2023. The lack of exits for VC-backed companies has created problems for the funds looking for returns and liquidity for their LPs. Even with the market in a state of turmoil, it will be interesting to see how VCs invest their capital and take advantage of market opportunities. VCs have always achieved their greatest returns when they take the highest level of risk. It looks like the VC industry is in for a tough stretch in 2023, but let’s not have a doom-and-gloom view based on only one quarter of activity.

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