The slowdown in venture capital funding has hit early-stage startups, and this part of the market is suffering one of the biggest declines in investment in more than a decade.
● The venture capital funds fell asleep while standing: 98% of the return on the high-tech boom remained on paper
In the second quarter, venture capitalists invested about $16 billion in early-stage deals in the U.S. — known as rounds A and B — down 22 percent from a year earlier, according to PitchBook data. It was the largest quarterly drop in funding. for early-stage startups since at least 2010, with the exception of a drop in the second quarter of 2020, when the onset of the global pandemic caused a temporary pullback in investment.
This retreat shows that investors are increasingly wary of risky investments such as start-ups, a significant shift in sentiment from recent years, when competition among venture capital firms led them to invest money earlier and earlier in the life cycle of startups. This is happening following a similar withdrawal in funding for startups in advanced stages, which are closer to the IPO and are therefore more affected by stock market declines.
This change shifts more power in Silicon Valley back into the hands of investors. For years, a flood of cheap money sent valuations soaring, and venture capital firms said they were spending less time researching and vetting companies and more chasing after founders to avoid missing out on deals. The pandemic has accelerated many of these trends, as demand for software services has increased to accommodate companies moving to remote work, and interest rates have been historically low.
Earlier this year, venture capitalists were upbeat about the early-stage funding environment, even as shares of publicly traded tech companies, from Doordash to Snowflake, tumbled. Early-stage funding in the US increased by 50% in the first quarter compared to the same period a year earlier, according to PitchBook data.
Slow down the volume of transactions or exit the startup market altogether
Within the new macroeconomic environment, the calculations have changed, and there is actually a freeze on investments in favor of investing in more mature start-ups, which are already in the growth phase. Venture capital firms that focus on early-stage investments often rely on money managers who have plenty of cash to increase the listed value of their holdings for subsequent funding rounds. But many of these big investment houses slowed their deal volume earlier this year or pulled out of the startup market altogether with the stock market declines, venture capitalists say, raising the bar for investing in the youngest companies.
Even funding for seed-stage deals, sometimes the first source of external funding for companies still developing their products, took a hit. Transaction volume in the US fell 11% to $3.9 billion in the second quarter compared to the year-earlier period, the first annual quarterly decline in nearly two years, according to PitchBook data.
Cool funding environment
“The environment for early stages of funding, seed and round 1, is the toughest I’ve seen in my career as a fund manager,” said Jeff Morris Jr., who runs a fund called Chapter One, which focuses on early-stage crypto startups. “In the short term, it will hurt.”
Amid this chilly environment, investors say even the newest startups are expected to demonstrate they have a clear path to generating revenue and profits. Such metrics were not always prioritized by investors looking to promote vibrant new companies last year, when record amounts of money and low interest rates fueled a race for ever-increasing returns.
The drop in investment for early-stage companies comes after the older companies experienced a few difficult months. Pandemic darlings including delivery company Gopuff and online events company Hopin — which raised three rounds of funding in less than a year — laid off workers in several waves in 2022. Startups in every field closely examine the balance sheets in order to preserve cash in anticipation of a deterioration in the financing environment, and are attentive to the warnings issued by venture capital investment houses such as Sequoia Capital and Lightspeed Venture Partners.
“In this climate, my whole perception has changed. It’s all close sales, close sales, close sales,” said Anuropa Ganguly, CEO of educational technology startup Prisms of Reality Inc, which wants to raise a round I in the fall. “When the going gets tough Moreover, it forces founders to be much more strict.”
Ganguly said she doesn’t believe the market has missed so much that it will affect her $4.3 million seed round, which she completed in March, but it will be more important for startups to hit financial milestones if they want to raise capital from venture capitalists on good terms.
Venture capitalists raised a record $139 billion in US funds last year, according to PitchBook, and have already raised $122 billion this year. The calculation includes an early-stage fund worth $1.9 billion funded in March by Founders Fund and an early-stage fund worth $2 billion Raised by Lightspeed Venture Partners in July of this year.
The large amount of committed capital means that venture capital funds still need to find startups to support, although the pace of investment may slow in some funds, said Nina Achadian of Index Ventures. She said Index partners now have more time to make decisions on new investments compared to last year, when popular founders sometimes had the upper hand in discussions about funding agreements.
Some seed-stage startups are already struggling to raise first-round funding, a stage in funding where investors typically expect the companies to show clear signs that they are gaining momentum among consumers. Many of these companies are now raising money in extension rounds, capital that is usually offered to investors at the same price as in the previous round, according to Achadian and other venture capitalists.
Start-up companies in the crypto field have been particularly hard hit due to, among other things, the large sales (selloff) in established crypto currencies such as Bitcoin and Ethereum. Venture capitalists poured $8.4 billion into early-stage blockchain startups in the second half of last year as this new field suddenly became hot. Since then, the numbers have dropped: in the second quarter of this year, only $2.4 billion was invested in blockchain startups, down from $3.1 billion in the first quarter, according to Crunchbase data.