A Quarterly Wink and a Glance at Venture Capital
Last year was certainly a challenging one for VC investment, both for VCs and founders. VC performance in 2023 was hindered by the collapse of Silicon Valley Bank, a difficult market for exits, and a tough market for fundraising. In 2023, there was $170.6 billion of VC invested in 15,766 deals, which was well below the $242.2 billion in VC invested across 17,592 deals in 2022. In fact, 2023 deal values were about $177 billion below the record levels achieved in 2021. It appears recession fears, the unstable geopolitical situation, relatively high interest rates, and the significant gap between founder and investor valuation expectations still plague the U.S. VC market. In a dismal year for VC investment, there was one bright spot: artificial intelligence (“AI”). AI companies accounted for about 20% of the VC deals in 2023 and one-third of all VC dollars invested.
Exit Markets Continue to Underperform
Q4 2023 only recorded eight completed IPOs generating about $1 billion of exit value. The IPO market is coming to a halt at a time when there are more than 700 private unicorn companies that have stayed away from the IPO market and are now adding to the IPO backlog. During 2023, there were only 1,129 exit events totaling $61.5 billion, which compares unfavorably to the 1,401 exits totaling $ 78.6 billion in 2022 and the 1,990 exits totaling $796.8 billion in the record year of 2021.
Many companies are staying away from the public markets due to the lack of strong financial performance and the large gap between private and public company valuations. Last year saw many companies go public at valuations significantly below the valuations of the last private rounds, and many private companies were not willing to concede on price. It now looks like technology companies considering an IPO must demonstrate the ability to scale revenues and achieve profitability in a reasonable amount of time. The ideal IPO candidate should be able to demonstrate 20% to 30% year-over-year revenue growth and 15% to 20% EBITDA margins.
Pre-Seed and Seed-Stage Investment Continues at a Slow Pace
In Q4 of 2023, $2.8 billion was invested in 1,176 pre-seed and seed-stage deals, making it the worst performing quarter of the year. For all of 2023, about $15 billion was invested in the pre-seed and seed stages compared to about $24 billion invested in 2022. For 2022 and 2023, median deal sizes for pre-seed and seed-stage deals have remained consistent at $600,000 and $3 million, respectively. Even with the decline in seed-stage activity in 2023, the median seed-stage valuation increased from $11 million in 2022 to $12 million in 2023.
Early-Stage Deal Value at Lowest Since 2017
In 2023, VCs invested $39.5 billion in 5,421 early-stage deals, and this represented a significant decrease from the $70 billion invested in 5,519 deals and the $87 billion invested in 5,997 deals in 2022 and 2021, respectively. Early-stage activity in 2023 was at its lowest level since the $30.6 billion invested in the early-stage space in 2017. Part of this decline is that many founders have been simultaneously trying to reduce cash burn and achieve their next milestone before trying to raise another round of capital. Conversely, many Series A investors have become exceedingly cautious and now expect to see a more developed product and customer base, traction, and higher levels of annual recurring revenue before agreeing to write a check.
Late-Stage Deal Activity Continues to Decline
Q4 2023 saw only $16.4 billion invested in 1,019 late-stage deals. This continued the decline in late-stage deal activity that began in Q1 2023. For all 2023, $80.4 billion was invested in 4,305 deals, which was down from the $94 billion invested in 4,687 deals in 2022. The lack of progress, exit activity and high interest rates created problems both for investors and founders of late-stage VC-backed companies. Many investors in the late-stage space have become increasing cautious, and this has led to far less capital availability for founders. I do not see this situation changing until declining valuations stabilize, the exit market returns to some level of normalcy, and there is a clearer picture where interest rates are headed.
Fundraising at Lowest Level Since 2017
In 2023, only $66.9 billion was raised by 474 funds, and this was well below the $172.8 billion raised across 1,340 funds in 2022. In fact, 2023 was the worst year for VC fundraising since 2017, when 662 funds raised only $46.8 billion. Without exit activity and the return of capital to limited partners, fundraising will continue to suffer. Also, with interest rates at relatively high levels, other asset classes with lower risk profiles are beginning to look more attractive to limited partners. The decline in fundraising is also happening at a time when VC dry powder of $302.8 billion is at a record high. Most of this dry powder belongs to funds that were formed in 2021 and 2022.
Down Rounds and Startup Bankruptcies Rising
Valuations are continuing to decline across the technology ecosystem, and this is causing a rise in the number of down rounds. Down rounds, which represented approximately 8% of VC deals in 2022, accounted for 20% of VC deals in 2023. Not all VC-backed companies were able to slow their cash burn in 2023, and many of those same companies couldn’t raise additional rounds of capital. Many were forced to close their doors and liquidate or file for bankruptcy. In fact, the number of startups that were forced to liquidate or file for bankruptcy doubled in 2023 from levels realized in 2022.
Outlook
Many VCs and founders are happy that 2023 is finally in the rearview mirror and are hopeful that 2024 will be much better. There are many reasons for optimism heading into 2024. AI and generative AI are on the rise and should attract significant VC attention and dollars over the next couple of years. After two years of a slow exit market, many hope that the M&A market and IPO markets will open up and allow funds to achieve necessary liquidity targets. Many believe that we should begin to see gradual declines in interest rates, which will help in a market recovery. Finally, with VCs sitting on $300-plus billion of dry powder looking for a home, it is only a matter of time before VC activity begins to pick up.
