IPO and Investment Activity is Slowing, but VCs Are Still Raising New Funds..for Now

enture capitalists started 2022 on pace for the industry to have its largest fundraising year on record, as an unprecedented number of firms hit the market to raise new and, in most cases, larger vehicles.

But now, the state of the VC ecosystem seems much more uncertain as the stock market takes a beating, inflation levels continue to rise, the Federal Reserve maintains its tight grip on monetary policy, and recession concerns send the market firmly into correction territory. 

The S&P 500 Index is down about 16% this year and the Nasdaq Composite is down more than 25%.

These struggles have started to spill over into the private markets where the number of initial public offerings came to a screeching halt in the early months of 2022 and venture investment began to drop off after an incredibly strong year in 2021. 

However, despite this slowdown, VC firms have continued to raise money for new funds in 2022, something that seems counterintuitive to broader trends that have been occurring in the industry.

So, what exactly is driving this? 

Well, it’s actually quite simple. The largest, most well-known VC firms continue to haul in dry powder, and the smaller, newer VC funds are struggling to keep their heads above water, like most of the industry in these turbulent times.

“You are seeing, I'd say, a bifurcation. The large funds are employing a very different strategy, meaning they have large late-stage strategies. They have seed fund programs. They have niche programs. So, they're much more diversified in both stages and the markets they're going after,” said Greg Becker, the president and CEO of Silicon Valley Bank, which banks a large portion of the VC and startup world, on the company’s most recent earnings call. 

He also added: “The funds that are having a harder time are the smaller funds, the first-time funds, the funds that, you know, it's Fund II or Fund III, but you really don't have enough distribution in the first fund or two. And so, there are some headwinds with that. So, you're getting a little bit of a mixed message. But the dry powder from the, you know, more stalwart firms is incredibly strong.”

Becker’s comments make perfect sense if you look at some of the headlines from earlier this year. For instance, in the first week of 2022 U.S. VC firms raised $13 billion across 15 funds, according to Pitchbook data. But $9 billion of that came from three funds raised by the extremely large and well-known VC firm, Andreessen Horowitz.

According to Pitchbook data from early May, U.S. VC firms had closed fundraising for more than $90 billion, which is already close to roughly two-thirds of what was raised in 2021.

Although the market is certainly unpredictable at the moment, it does make a certain amount of sense that investors are still interested in venture funding. Why? Because VCs are in a prime position to finance the new technological innovations that will be needed in the post-pandemic world. 

Investors also might be eying an opportunity with what’s going on in the public markets to invest in startups at lower valuations after they exploded during the pandemic.

But can this kind of fundraising from VCs last?

VC financing of startups has significantly slowed at this point. Earlier this month, Crunchbase reported that VC funding dropped another $5 billion from March to April and could hit a 12-month low. In the first quarter of the year, global VC investment hit nearly $145 billion, lower than any quarter in 2021 but still strong all things considered.

Many suspect that VC fundraising levels over the next year or two will be closer to that of 2019 or 2020.

A slew of issues could slow capital flowing into VC firms. For one, many limited partners such as pension funds and endowments can only dedicate a certain portion of their portfolio to venture capital, due to the high level of risk involved. With valuations down and the market incredibly volatile, LPs may have to be more careful and therefore less aggressive in investing in VC.

Additionally, it may seem high level, but the Federal Reserve pumped an unprecedented amount of money into the economy during the pandemic. And as the Fed begins to unwind its nearly $9 trillion balance sheet, that could have effects that reverberate through public and private markets and lead to a decrease in liquidity.

Rising interest rates could also lead to a slow down in funding because as the Fed raises its benchmark overnight lending rate, bonds and other safer assets get more attractive for investors because they yield more but are safer. However, higher rates could also make VC funding more desirable among startups because rising rates also increase the cost of traditional debt.

Beezer Clarkson, a partner at Sapphire Ventures, told Crunchbase last month, that usually in the public and private markets, what goes up typically must come down eventually. For the past few years, dry powder has been high, venture groups have returned to the market much quicker than normal, and startup raising, in general, has been much faster and bigger.

"I would be shocked if we were [to raise] anywhere close to [what we raised in Q1] for the remainder of the year," Samir Kaji, the founder and CEO of Allocate, a VC investment platform, told Pitchbook. "It's hard to envision a scenario where we top last year's fundraise."

For those who have known nothing but a never-ending bull market for their entire professional lives, this is can be an unsettling time. But the idea that the bull market would never end - despite what a large number of Twitterati may say - was always fanciful. Markets are inherently cyclical and periods of correction are of course inevitable!