Venture capital investors, brace yourselves for a bumpy ride in 2023. According to the recently published 2023 U.S. Venture Capital Outlook by PitchBook Data Inc., venture growth deal value is expected to take a dive below $50 billion. But fear not, it’s not all bad news.
The report, which is compiled by PitchBook analysts, predicts a decline in investment in late-stage and more mature companies. Nontraditional capital that had been deployed opportunistically in the past few years is now retreating from venture strategies, which is driving the drop in capital availability. Consequently, many companies will be chasing much lower capital availability.
Additionally, there may be fewer companies looking to raise late-stage venture capital. Many companies will instead focus on sustainable growth and cost-cutting measures to stay away from the difficult capital-raising market.
With capital declining at the top end of the market, the report also predicts that the Morningstar PitchBook U.S. Unicorn Index will show a negative return through 2023. While the index returned 1% growth in 2022 compared with a 59.1% decline in the IPO Index, the pace of new unicorn creation has fallen precipitously in recent months.
The report points out that in November, there were fewer than 10 completed rounds with a valuation of $1 billion or more, well below the 48 in January. C and D rounds are also expected to be hit hard with down rounds, implying valuations lower than the previous round, since companies at this stage are currently the most starved for capital.
Emphasizing how much the market has shifted, the report finds that 3.5 times more capital was demanded by late-stage companies in the fourth quarter than the deal value observed. The late stage was the most overextended during the “VC dealmaking frenzy” of 2020 and 2021. As these companies grapple with the new reality of higher interest rates and stricter deal terms, they will not be able to raise at their previous paces, high cash burn rates, or valuation levels.
But while the top end of the VC market may suffer in 2023, the good news for those entering the market is that seed-stage startup valuations and deal sizes will continue to soar and reach new annual highs, despite a slowdown in total deal value and count.
The report argues that seed-stage startups are more insulated from public market volatility because they’re in the most nascent stages of the VC lifecycle. Having just raised money, they are further away from an initial public offering and can bide their time until paths to liquidity reopen.
Just how long the path to liquidity will reopen is not known, but it’s unlikely it will be in 2023. The report predicts that special-purpose acquisition company IPOs and mergers will continue to decline. Elevated market volatility dramatically depressed valuations and halted public listing through 2022, not only traditional IPOs but SPAC listings as well.
Although the report describes the IPO market as nearly frozen, it claims that SPACs will be hit harder because of regulatory scrutiny of the use of SPACs as a way to reach public markets faster than a traditional IPO.
In a nutshell, U.S. VC fundraising is expected to fall between $120 million and $130 billion in 2023 as investors grapple with liquidity concerns and consider alternative investments in other asset classes aided by rising interest rates.
The report paints a picture of a changing VC landscape where the top end of the market will be challenged while the seed stage will continue to grow.
As with any market downturn, it’s important to be patient and ride out the storm. For those entering the market, the seed stage might be the perfect place to start. For those already in the market, it’s time to reassess and adjust their strategies to weather the upcoming challenges.