Hello Insiders, Venture funding in the year 2022 started off with a bang following a record-breaking 2021. However, the macroeconomic turbulence in mid-2022 led to a global venture funding retrenchment that has pushed the industry into a funding winter that is expected to continue next year. There were some rare positives despite the funding dip. Vibha and I have recapped the top trends for this year. Look out for our 2023 predictions, which will be published on Dec. 30. Happy holidays! | |  Karan | |
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The record-setting venture capital deal-making activity from 2021 continued into the early part of 2022 until Q1, after which global venture funding dropped consistently in all subsequent quarters. Venture capital firms started taking a conservative approach to investments after Q1 2022 due to a tough macroeconomic landscape, geopolitical challenges, rising global inflation, and heightened prospects of a recession. Except for 2021, the deal activity crossed all preceding years. More: - Global venture funding in Q3 amounted to $81B, less than half the funding from the same period last year.
- U.S.-based startups nabbed $43B of the funding.
- Funding in Q3 was down 53% YoY and 33% QoQ.
- The funding dip impacted late-stage startups the most, which raked in $40B in Q3 despite being down 63% YoY.
- Global venture funding totaled $329.2B in the first nine months of the year and is expected to reach $438.9B by year-end.
- Global venture funding amounted to $630.3B in 2021 and $298.2B in 2020.
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An estimated $290.1B in committed capital was held by U.S. venture firms, in the first half of the year, as "dry powder," according to Pitchbook. As inflation rose and the economic downturn worsened, capital allocators became cautious of deploying funds; global venture capital deal value declined 66.7% YoY in November to $20.5B. More: - Despite the record dry powder, venture funds are now cautious about committing funds as the U.S. economy is predicted to enter a recession in 2023.
- Low deal activity did not equate to low fundraising, as a record $150.9B in venture funding was raised as of the end of Q3 2022.
- In Q3, $14B in exit value was created — the lowest since Q4 2016, per Pitchbook's Q3 2022 PitchBook-NVCA Venture Monitor.
- Highlighting the accumulation of dry powder, Jon Sakoda, founder of early-stage venture firm Decibel Partners, expects the "floodgate" to open at some point next year.
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Investment firm Galaxy Digital's research revealed that a collective $121B venture funding was raised in the crypto space, but only $32B was deployed since the start of 2022. The post-pandemic bust cycle pushed the cryptocurrency and blockchain industry to destruction, as firms like Three Arrows, Voyager Digital, Celsius, BlockFi, and FTX went bankrupt. More: - As of June 30, 2022, 415 crypto venture funds were launched compared to 999 in 2021.
- $5.5B in venture funding was deployed in Q3 2022, while $8B was deployed in Q2 2022, per Galaxy's research. The crypto industry also noted an 80% decline in venture fundraising in Q3 2022.
- Sequoia, Silicon Valley's prominent venture firm, raised a $600M crypto-focused fund. Although it has reportedly only deployed 10% of the fund, the uncertainty in the market due to crypto winter and rising interest rates has left investors questioning how the rest of the money will be deployed.
Zoom Out: - Sequoia Capital had invested $214M — prior to launching the $600M crypto-focused fund — in the now-bankrupt FTX.
- Divya Gupta, a Sequoia partner who worked on seed- and early-stage investments in cryptocurrency and artificial intelligence, announced his departure from the firm after FTX's implosion.
- Since the collapse of the $40B stablecoin TerraUSD in May, $2T in market value has been wiped from the digital assets industry.
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Deal terms tipped in investors' favor in 2022 due to the high amount of dry powder available for deployment with investors coupled with the slowed rate of investing. VCs were able to make investments at lower valuations, with increased liquidity preferences, better downside protections, and cumulative dividends. More: - Pitchbook's Q3 U.S. VC valuations report shows that cumulative dividends so far in 2022 were at 18.7%, up from 16.7% in 2021.
- Investors were able to snatch higher liquidation preferences, with Loius Lehot of Foley and Lardner estimating that 60% of mid- and late-stage deals seen by him came with 2x to 3x liquidation preferences.
- Tonal offered investors a 2x liquidation preference at its recent $100M funding round.
- Headline founding partner Mathias Schilling noted that few deals are being done at 3x liquidation preference.
- There were fewer down rounds than initially anticipated, mostly as some startups were flush with cash in 2021.
- Founders also preferred to raise structured financing rounds rather than raise down rounds. However, these deals came with restrictive terms favoring investors.
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As soon as the venture funding started receding this year, institutional venture capital firms cautioned their portfolio companies to brace for a downturn by decreasing burn rates and extending their cash runway. Investors expect the venture funding dip to last for two years, so they asked startup founders to make tough decisions, like laying off employees and curbing growth plans. VCs advised founders to be open to lower valuations in case they intend to raise capital in the near future. More: - Andreessen Horowitz asked founders to recalibrate their valuation expectations.
- Software startups could expect valuations equal to 5x their forward revenue rather than the 12x multiples they expected in the past.
- The firm further advised startups to focus on reducing their burn multiples.
- Sapphire Ventures co-founder Jai Das told portfolio startups to have at least 18 to 24 months of cash runway.
- Insight Partners managing director Hilary Gosher advised startups seeking to grow to figure out what valuation they want at the next round of funding and then reverse calculate the revenue growth needed to achieve that valuation.
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U.S. venture debt funding volume reached $17.1B in the first half of 2022, marking an increase of 7.5% YoY. During the same period, venture funding declined 8% to $147.7B. More: - Startups with high cash burn rates sought debt funding as investors slowed down equity capital deployment.
- Lending firm Hercules Capital Inc. committed to lending $1.66B in the first half of the year as the market downturn began.
- "If the market was up and to the right and green, those companies wouldn't be talking to us," noted Hercules' chief Scott Bluestein.
- Private equity firm Blackstone reportedly expects to lend $2B to startups over the next few years. According to the Information, KKR & Co. is also looking to expand its lending to venture-backed startups.
- OneLogin, an identity management startup, was forced to take out $26M debt in 2017 due to a lack of backers; CEO Brad Brooks says, "debt is an invisible adult hand" that forced difficult discussions within the company. The company was acquired for $500M by Quest Software subsidiary.
Zoom out: - Venture debt funding has increased worldwide, including in India, where it has only been present for the last 5-7 years.
- In the first five months of 2022, startups raised $190M in debt as equity funding declined.
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In 2022, the median net internal rate of return (IRR) for VC funds set up from 2017 to 2020 witnessed a decline of 3.6% and 3%, respectively. PitchBook preliminary data recorded a -2.3% IRR in Q2 2022. This is the first time venture returns have fallen below zero since 2016. More: - Sean Engel, Managing Director with Top Tier Capital Partners, noted that they are "seeing a 10% decrease in holding value year-over-year."
- The decline could be associated with two types of companies;
- Pre-IPO companies whose valuations were reset in line with the comparable publicly traded companies.
- Companies listed in the market last year whose stocks are yet to be distributed to the limited partners.
- The returns on venture investments could be down by 20% once year-end audits are completed, Engel added.
- The data recorded by Carta indicated that funds established in 2021 were an exception as they recovered from the dip below zero, not uncommon during the initial fund lifecycle.
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San Francisco-based venture firm Bessemer Venture Partners became a registered investment advisor (RIA) in mid-2022, following in the footsteps of other institutional investors like Andreessen Horowitz, General Catalyst, Greycroft, and Sequoia Capital. Many traditional venture firms are moving away from pure venture investments and registering as an RIA with the U.S. SEC in a bid to hold more public equities, cryptocurrency, and secondary shares in their portfolio. More: - Venture firms can invest under 20% of their capital into other VC funds, digital assets, or secondary shares.
- However, registering as an RIA provides firms with the ability to supplement their traditional venture investment and allocate more than 20% of their funds across other asset classes, including cryptocurrency tokens and secondary shares.
- VC firms often want to purchase additional shares of portfolio companies that go public in a bid to maximize their investments.
- Since VCs must have closely monitored/mentored the startup, tracked its growth, performed due diligence closely, and evaluated the firm's strategy, keeping shares after a public market debut can help VCs to reap the benefits from the company's growth even after its IPO.
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Healthtech companies remained resilient during the uncertain market environment as the median deal valuation increased to $45M, ~33% higher than the 2021 median of $33.9M. Startups in the sector raised $26B through November across 1,413 deals, per PitchBook data. More: - Compared to SaaS, artificial intelligence, machine learning, and FinTech, the healthtech vertical continued to be buoyant as the Fed continued quantitative tightening.
- Dealmaking remained below 2021’s record of $34.5B — a 25% decline.
- The sector also witnessed decreased M&A deals, with only 266 transactions valued at $137.8B as of Nov. 15.
- According to PwC, 2023 could be an active year, with deals between $5B to $15B expected in the first half of the year.
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Venture firms are eager to reap the rewards and capture value by consciously investing in diverse founders because they believe that investing in underrepresented and diverse founder-led startups has untapped potential for returns. A study done last year shows that returns from diverse founding teams are higher than homogenous ones. The average exit multiple for founding teams that were ethnically diverse was 3.26x, which was 30% higher than the 2.5 multiple for founding teams that were exclusively white. More: - However, despite the strong rhetoric, a lot more needs to be done in this sector.
- Amazon will invest $150M in venture funds, accelerators, and incubators that back Black, Latino, women, LGBTQIA+, and Indigenous founders through its Amazon Catalytic Capital initiative.
- Former Microsoft CEO Steve Ballmer has invested $400M in four funds-of-funds that back Black-led startups.
Zoom out: - Black-founded startups secured only 1.3% of total venture funding in 2021.
- Funding for Latino founders and solo female founders fell in 2021.
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 |  | Karan Chafekar is a Management Consultant, Business enthusiast, and Licensed Pilot.
Vibha Chapparike is a Freelance Writer & Editor at Inside.com. With her post-graduation in Management and Finance completed, Vibha is expanding her knowledge in venture capital, business, startups, and technology. She has had a career in public relations and communications. | | | | Editor | Aaron Crutchfield is based in the high desert of California. Over the last two decades, he has spent time writing and editing at various local newspapers and defense contractors in California. When he's not working, he can often be found looking at the latest memes with his kids or working on his 1962 and 1972 Fords. | |
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