What NOW?!?! (for Venture)

what now for venture capital

In the midst of high inflation, rising (fluctuating?) interest rates and a global economic pullback, we’re right there with bankers, financial advisors, private equity executives, and other venture capitalists who are all asking, “So what NOW?!”

The faster we fail, the more we learn.”

Eric Ries

This quote encapsulates the essence of the Lean Startup methodology, which Ries himself developed. Ries emphasizes the importance of embracing failures as opportunities for growth and learning, and this mindset applies to both entrepreneurs AND investors.

Should you remain calm? Is it time to take action? That might depend on your company, job function, and myriad other factors.

What’s Going On Now?

Starting in 2022, valuations declined, causing companies to think twice about completing deals with cut-rate price tags.

Worldwide, the total value of M&A deals fell by 38% and volume declined by 18%; in the U.S., deal value fell by 39% and volume fell by 15%.

In the venture capital space, there was also a steady slowdown in startup funding through 2022. Deal count slowed roughly 14% from the record highs of 2021, according to data from PitchBook as of Dec. 31, 2022.

Yet, in 2022, VC fundraising didn’t falter. VCs raised $162.6 billion, breaking
the previous year’s record of $154.1 billion, per PitchBook.

However, the big, well-established funds were the prime beneficiaries of those investments. Newer funds, like Cassandra Capital, faced a much more challenging fundraising environment looking into 2023.

A cloudy forecast leaves dealmakers struggling with uncertainty while they also ponder industry-specific forces that may create risks— and opportunities —in the months to come. There’s no consensus among economists and other forecasters about the direction of the U.S. economy.

Companies selling discretionary items, like furnishings or fashions, may face a tougher road than businesses focused on consumer staples.

Venture capitalists are now having to triage their portfolio companies, demand that they do more with less cash, and let the weaker ones “die.” This strategy, combined with complete transparency and high communications with boards and LPs (investors), will remind the whole ecosystem that this is a cycle.

Venture capital is the highest returning asset class and there’s always opportunities in down times, and most LPs are currently “underweight” in venture allocation. Valuations will increase, and after all, the valuation number is really only important at a company’s exit… otherwise it’s all fuzzy math prognostication.

So, What’s Next?

Dealmaking might regain some of its mojo at the end 2023, with mounds of capital patiently waiting on the sidelines and investors tempted by lower valuations on companies with great technologies. But, we’re not betting the farm on much activity this year.

Strong companies are likely to acquire weaker competitors as laggards struggle financially, default on loans, and beat paths to the exit.

Layoffs, market turmoil, and other disruptions are likely to roil sectors like fintech and media, challenging investors but also creating opportunities as new enterprises and upstart technologies take root.

Our prediction (as much as we can make one) for 2024 is that companies will be forced to set expectations lower as dealmakers seek to find a new level for valuations in VC deals…

Expect a great awakening in the second half of 2024, when the wave of companies that raised at sky-high valuations in 2021 run out of capital and are forced to consider M&A or a downround in a much more skeptical market.

If you’re an angel investor, venture capitalist, or private equity manager, I’d love to hear your thoughts!

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