Never has so much money poured into venture capital.
In the first quarter of 2022, US VCs raised more money for new funds than in the entirety of 2019, according to Pitchbook. But those new funds didn’t translate into more investments into startups. Instead, global VC investment fell sharply in the first quarter, down from record highs the year before.
“We’ve rapidly, perhaps brutally, transitioned from a hyper frothy VC environment to a world where many deals are not getting done,” wrote Matt Turck, a partner at the VC firm FirstMark, in a blog post at the end of April.
The slowdown is a sign that investors are reassessing the landscape in light of inflation, the war in Ukraine, a poor IPO market, and the chance of a recession.
Yet “there is a TON of dry powder out there,” said Jeffrey Bussgang, a partner at Flybridge Capital Partners. “All the major growth stage investors—such as Tiger, Softbank, Insight, Sequoia, Thrive, and General Catalyst among others—have raised massive new funds.”
The question hanging over the startup sector is where all that money will go. Based on data from PitchBook and conversations with VCs, here are three possible answers.
The biggest driver of the VC reset is arguably the cooling of the public market. A PitchBook analysis in March found that the 10 biggest tech IPOs of last year had all lost between 18% and 68% of their value since going public.
But the younger the startup, the less it has to worry about public markets; a seed-stage company might be a decade away from an IPO. So in 2022 VCs are pouring more money into earlier stage startups in the hopes of waiting out the lull in IPO interest.
“We’re still seeing plenty of activity at the seed stage,” said Sarah Hodges, a partner at Pillar VC. And “we are seeing later-stage firms move earlier as they recognize the opportunity in seed.”
What kinds of companies are getting funded? Hodges mentioned biotech and sustainability. Bilal Zuberi, a partner at Lux Capital, pointed to semiconductors, climate tech, defense tech, supply chains, and agriculture.
“After a decade plus of building consumer and then enterprise SaaS companies, I anticipate VCs to try to look for diversity and longer term bets,” Zuberi told Quartz.
Oh, and of course, both Hodges and Zuberi brought up crypto. Despite the VC pullback, crypto startups in the US raised a record amount in the first quarter of 2022.
Crypto startups were an exception to the decline in giant, later-stage deals. FTX, the cryptocurrency exchange, raised $800 million in January, including from Softbank’s Vision Fund 2—despite the fact that shares in rival Coinbase are down by almost half in its first year since going public. In another sign of crypto momentum, Andreessen Horowitz, one of the biggest crypto backers in Silicon Valley, recently announced a new research center dedicated to the topic.
Unlike the US, European startups kept their momentum going into 2022. Despite the war in Ukraine, VCs invested €27.5 in Europe—slightly higher than the pace in 2021, which, like in the US, set a record.
European fintechs had a particularly strong quarter, led by companies like London’s Checkout.com and France’s Qonto. The UK and Ireland led Europe in terms of total VC dollars invested.
(Asia, which is a larger VC market than Europe, also saw declines in the first quarter of the year. One partial exception was India, where Andreessen Horowitz plans to invest.)
When the music stops
None of these exceptions can last forever.
Crypto can stay hot for a while based on the momentum around NFTs, but the prospect of regulation looms as large as the macro factors dragging down the rest of VC. And those factors apply just as much to Europe, which is also at risk of tipping into recession; there are already signs that European VC activity is slowing. The seed and early-stage markets can absorb some extra capital while investors reassess, but the deals are by definition smaller and there’s simply too much money parked in VC funds to dole it all out in $1 million checks.
“VC investment is usually cyclical,” said Steven Kaplan, an economist at the University of Chicago. It rises and falls with the overall economy. If there is a recession in the US this year—there’s about a one-in-three chance of that—expect VC investment to dip further. Luckily, if there is a recession it’ll probably be mild. And since 2002, VC funding has only once gone down two years in a row: a slight decrease in 2007 followed by a sharp one in 2008.
So the most likely outcome is that VC activity will be ramping up again by the end of 2022. The sky-high valuations that were reported last year might not return so quickly.
“Valuing companies at 30-100x revenue was never sustainable. At some point, the market was going to correct, but no one wanted to be the firm that was left out while the music was still playing,” Bussgang told Quartz.