Navigating the Venture Capital Funding Downturn

For venture capitalists, 2023 is proving to be bleak. Q1 has been the worst quarter for early-stage investing in 5 years, with the startup industry struggling to raise funds and stay afloat. Venture capital (VC) funding in startups experienced a significant decline as funding has been cut in half across North American and European firms.

However, VCs raised over $540 billion of “dry powder,” capital that has yet to be invested, by the end of Q1—a record for the industry. So while funding is certainly available, VCs have lost faith in startups and their ability to manage investments. Decreased funding is having tangible consequences: this past April, the reported value and volume of funding rounds were the lowest in any month since January 2020.

So what’s causing this hesitation in investing within the VC space? Moreover, how can emerging companies survive this loss of industry faith? 

Using the AlphaSense platform, we explore the events that laid the foundation for VC’s shaky landscape, the current state of the industry, and what companies will need to do to survive upcoming quarters.

The Demise of SVB and Tech Investment Funding

Tech has been a significant driver of the startup industry, but coupled with sector downturn and escalating macroeconomic conditions directly affecting supply chains, enthusiasm for riskier investments is minimal. Consequently, startups are pressed for capital but are left with limited, unfavorable options: pursue unfavorable debt deals, accept a decline in their valuation, or potentially face insolvency.

There’s no denying that the fallout of Silicon Valley Bank (SVB) and Silvergate reinforced skepticism amongst VC firms. A large portion of SVB’s business focused on venture capital and private equity—a sector that has performed well over the past decade. High concentration and exposure to one industry create high risk, so when things got bad for their non-diversified portfolio of clients, things went south for the bank. 

But it’s worth mentioning that even before the SVB collapse, founders were already experiencing unfavorable business environments from early-stage investors. So many new, unseasoned founders likely never experienced a prolonged volatile macroeconomic environment like the one that continues to define the market. Especially after the SVB collapse, it became clear that founders could raise cash but were clueless when it came to managing funding and the risks that come with it.

The bottom line: businesses typically grow into money over time, however, post-COVID ushered in a tech frenzy that saw a flow of funding into the startup scene. What came about were cash reserves that far exceeded the needs and size of a company, leaving some startups with $200+ million dollars in cash to manage a business with 20 employees.

The Current State of VC

The dynamic between founders and investors has left startups struggling to raise funds, while investors eager to capitalize on rising tech valuations are becoming increasingly sparse. However, 2022 and Q1 of 2023 weren’t completely barren of lucrative activity. 

According to Forbes, US venture firms collected $162 billion in funding last year—a value that surpasses 2021’s total in just three quarters. Additionally, 75% of commitments closed in Q1 and Q2, denoting a significantly slower second half of the year as economic uncertainty plagues the market. The major forces behind this fundraising activity? Large funds with $1 billion-plus in capital to dole out, while smaller-sized funds diminished.

A majority of that capital came from two major lifts by OpenAI and Stripe—each raising billions in recent months and contributing to North America’s uptick in VC funding. However, early-stage numbers dropped as investors continued to hoard their record levels of dry powder. 

Overall, North American funding in Q1 2023 reached $46.3 billion—nearly half (46%) the value raised over the same period last year. Without the OpenAI and Stripe deals, Q1 venture funding would have seen a 60% decline from the same period last year. This inactivity is leading founders to restructure their financing plans to survive funding-less quarters. 

“Tightening monetary policy and the downturn in public company multiples and valuations have continued to impact venture capital investment activity. Quarter-over-quarter activity in 2022 dropped off steadily. According to PitchBook, in Q4, an estimated 936 deals closed for a total of $1.35 billion, the lowest quarterly deal value since the second quarter of 2018. For many companies, prior year plans of growth at all costs have shifted to revised plans of conserving cash at all cost.”

– TriplePoint Venture Growth BDC Corp. | Q4 2022 Earnings Call

Surviving Investment Downturn

There’s no single solution to navigating these unpredictable times, which is why every founder and company needs to develop a long-term cash strategy (e.g., establishing a professional finance team). Finding a CFO experienced in tough economic conditions is vital to long-term success. Most likely, it will become criteria for investors as their demands grow to include putting experienced finance teams in place to better manage funding.

Further, founders are being forced to cut back on operational expenses and pivot their business models. Specifically, companies are agreeing to terms of funding that aren’t as favorable as they once were, like higher equity stakes or lower valuations, which discourages founders from scaling up on their ideas. So how can the slack that comes with layoff be picked up? AI is an option that major firms are adopting. 

AI can assist in data analysis, predictive analysis, portfolio management, due diligence, and deal sourcing. More so, AI can complement human decision-making within the space by mitigating avoidable risks. For most VC firms, funding decisions have been based on “gut feelings” and limited research. However, according to Gartner, a leading research and advisory firm, it is projected that 75% of venture funding decisions will be based on data and analytics provided by AI rather than relying solely on intuition.

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