Venture capital deal activity has cooled off as the technology sector faces a downturn brought on by rising interest rates and profitability concerns.
VC firms, meanwhile, are hoarding capital on the sidelines.
“What we saw across stages in the last couple of years was this incredibly fast pace,” Deena Shakir, partner at Lux Capital, told Yahoo Finance Live at the Collision Conference in Toronto (video above). “You’d see a pitch and the founder would have 10 term sheets within 24 hours without the type of diligence that you would want to do. That’s not really happening anymore. There is a slowdown that’s happening... in terms of the pace of doing rounds and in terms of the capital deployment.”
While valuations for both publicly listed tech companies and late-stage private firms have fallen sharply, recent data points to plenty of capital still waiting to be deployed.
Funding rounds have brought in more than $106 billion so far this year, bringing the total capital available for U.S. funds to $230 billion, according to Pitchbook data.
“I think there’s a big disconnect between the narrative that you hear from the media or directly from VCs and the actual data that’s coming through,” Kyle Stanford, senior VC analyst at Pitchbook, told Yahoo Finance. “Deal count is extremely high. There’s 3,600 funds that raised money in the past four years, so there are a lot of investors in the market. That’s $230 billion of dry powder.”
Non-traditional capital driving deals
One reason VCs continue to raise funds at a robust rate, according to Stanford, is record levels of capital flowing in from non-traditional sources. Non-traditional investments — driven largely by private equity firms, hedge funds, and mutual funds — accounted for nearly 40% of global deal count participation.
“We have seen these non-traditional investor types really dive head first into VC and become much more entrenched in the market than they had before the financial crisis or before the dot-com crash,” Stanford said. “So from a corporate perspective, we believe [valuations] will stay high.”
With $500 billion on the sidelines globally and more than 1,000 deals closed in the first quarter, companies this year have raised more first-time institutional capital than any other quarter prior to 2021.
There has also been a shift in where capital is being deployed, recent Pitchbook data indicated. Stanford said VCs are more likely to back companies that are seven or more years away from an IPO because they won’t be compared to similar competitors that are already publicly listed and have seen big declines.
“There’s a lot of leeway that investors seem to be giving them, even if those terms are getting a little more restrictive,” Stanford said. “When [investors] value [later-stage deals] they are looking to the private versus public earnings, which obviously haven’t been doing well. That’s going to make it really difficult to price those rounds.”
That has contributed to more “down rounds,” in which private companies offer additional shares for sale at a lower price than in previous financing rounds.
For instance, in March, grocery delivery company Instacart, one of the most valuable venture capital-backed startups, took the unusual step of slashing its own valuation by roughly 40% in acknowledgment of the slowing momentum in the delivery space.
And on Friday, buy now, pay later company Klarna announced it was considering dramatically cutting its valuation from $45.6 billion to $6 billion for its latest funding round.
Overall this year, the exit value and the number of exits have fallen significantly, coming off a whirlwind year in 2021 where U.S.-based VC companies generated a record $784 billion in exits.
However, despite the skepticism, late-stage deals are still happening — they’re just occurring through massive buyouts that fall out of the purview of VC in many cases.
Though megadeals can be as precarious as Elon Musk’s proposed acquisition of Twitter, they do signal that there’s still opportunity.
"VCs have become more cautious over the last few months against this macroeconomic backdrop, and as a generalization, I believe that the bar for investment has gone up,” Mary D'Onofrio, partner at Bessemer Venture Partners, told Yahoo Finance. “That being said, there are many firms with dry powder, so as valuations reset and bid/ask spreads with founders reduce, I believe that firms will begin to take more bets."
'Every company needs to be rethinking their strategy'
Lux Capital's Shakir is quick to point out that comparisons to the dot-com crash are misplaced, largely because of different macroeconomic factors surrounding the latest downturn such as global inflation and fears of rising interest rates.
However, Lux Capital is still applying many of the lessons that allowed the firm to emerge successfully from the tech crash twenty years ago to weather the latest downturn.
“We’re telling our companies to make sure that they’re keeping a close eye on [cash] burn, that they’re thinking long-term and have plenty of reserves,” Shakir said. “The trend that may have seemed normal for the last couple of years of raising every three to four months at a three to 4X valuation is perhaps not going to be the case.”
What VCs are looking for hasn’t changed for the most part, though they may be more interested in companies that have taken a more considered approach to growth in the current economic conditions.
"I'm looking for companies that show solid fundamentals and that are prioritizing efficient growth over a 'growth at all costs' model,” D'Onofrio said. “The priority to find companies with strong teams in large markets with product advantages has not changed, but as the capital markets have dried up somewhat, there is a greater emphasis on companies that are disciplined about spending, can show ROI on spend, and control their own destinies."
During a panel discussion at the recent Collision Conference in Toronto, a group of VCs agreed that it’s not a great time to raise money but it is an important time for founders to reassess their priorities.
"There are all kinds of challenges you have as a founder. ... In the last couple years, it was much more difficult to hire people, so you had to think about how to hire people in a different way or pay them more,” Beth Ferreira, general partner at FirstMark Capital, told the Collision audience. “Now, we have this challenge that capital is harder to get and is more expensive."
Ferreira added that "every company needs to be rethinking their strategy. So if you're not really thinking about where you are, how much you're spending, and what your strategy is, you're probably doing your company a disservice. I think that's across the board, everyone needs to be doing it, every single sector."
Akiko Fujita is an anchor and reporter for Yahoo Finance. Follow her on Twitter @AkikoFujita
Allie Garfinkle is a senior tech reporter at Yahoo Finance. Find her on twitter @agarfinks.