Fundraising by venture capital funds hit a multi-year low in Q4 2022. What’s driving the slump in the sector which was booming just around a year back?
According to Preqin Ltd., which tracks venture-fund data, venture capital funds raised only $20.6 billion in Q4 2022—a YoY fall of 65%. In absolute terms, it was the lowest fourth quarter fundraise since 2013.
Also, limited partners invested in 226 venture capital funds in Q4 2022 which is only about a third of what they did in the corresponding quarter in the previous year.
The venture capital industry witnessed an unprecedented boom between 2020-2021. According to the data from Pitchbook, US VC-backed companies raised $330 billion in 2021. Not only was it a new record but also double the previous record which was incidentally hit in 2020 only.
2021 was also a record year for the stock markets in terms of new listings. Thanks to a flurry of IPOs and SPAC mergers, many venture capital funds managed to exit their investments at good valuations.
Also, 2021 was the first ever year when US venture capital fundraising surpassed $100 billion, $128.3 billion to be precise. The fund-raising rose almost 48% as compared to 2020.
Just around a year later, the venture capital industry is in the news for mostly wrong reasons. Some firms have even lowered the fees that they charge to limited partners. Profits of venture capital firms have also nosedived.
Venture Capital Fundraising Tumbled in Q4 2022
The slump in Q4 2022 fundraising puts a number to the industry’s pain. There are multiple headwinds and challenges that the sector is facing. Firstly, the boom that we saw in 2020 and 2021 was not sustainable and was led by the euphoria that was further compounded by Fed’s accommodative monetary policy.
However, in 2022, the Fed reversed course as it became obvious that inflation wasn’t all that “transitory” after all. The US central bank raised rates to multi-year highs last year. In a matter of one year, the Fed raised rates from zero bound to nearly 5%.
The Fed’s rate hikes negatively impacted the venture capital industry in several ways. Firstly, higher rates make risky investments like venture capital less attractive. Also, the opportunity cost of partners that invest in funds rises.
Secondly, the Fed’s rate hikes have led to a sell-off in growth stocks. The US IPO market was virtually dead in 2022 after a record-breaking 2021. The fortunes of the venture capital industry are interwound with the IPO market.
A stalled IPO market meant that existing venture capital funds could not make exits in 2022 which also lowered the fund inflows of partners in existing funds.
Fed’s Rate Hikes Worked to the Nemesis of the Venture Capital Industry
Fed’s rate hikes worked to the nemesis of the venture capital industry. The macroeconomic slowdown, which the rate hikes are only compounding, is not helping matters either.
Simultaneously, there has been a funding winter for many startup companies. While names like OpenAI and SpaceX are still getting good interest, many other startup companies struggle to raise funds. There is a guide on how to invest in startup companies.
Also, with fund flows drying up, venture capital funds are also getting more selective about deals. Many startup companies raised funds at a big haircut to their previous valuations.
Miguel Luiña, a managing director at Hamilton Lane said, that funds “want to be patient in this market and wait for the right opportunity to come around.” He added, “Managers have slowed down the pace and aren’t coming back to market.”
Tech Stocks Have Crashed
Tech companies have typically been a favorite of venture capital funds. Most newly listed tech stocks have slumped and in many cases are fighting a survival battle. Some newly-listed tech companies have gone private within two years of listing.
Many SPACs dissolved last year amid the slump in tech stocks, which was the largest target pool for them. A lot of tech companies also delayed their IPO plans amid the deteriorating macro environment. There is a list of some of the upcoming IPOs.
Overall, the venture capital industry is facing multiple headwinds which might not wither away in a hurry.
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