Recently, The Economist featured a report about a surprising state of the venture capital industry in early 2023 sitting on hundreds of millions of dollars of dry powder. Venture Capitalists raised $150bn in fresh cash in 2021, which seemed like a record, but only a year later, in 2022, they raised more than $160bn. How is it possible that almost $300bn is waiting to be spent? These days, early-stage firms are cheap and their expenses are lower, but still we are facing the reality with a huge amount of dry powder.
One of the reasons is certainly the rapid rise in interest rates around the world. Since the start of 2022, the value of stocks has dropped and so investors are moving their capital into safer assets such as cash or government bonds.
Public market slowdown influenced expected returns for investors in private markets. For example, “Nasdaq”, where top Silicon Valley names are listed, has lost more than a fifth of its value in 2022. It means that start-ups plan to exit to public markets should expect lower valuations than in the recent past.
Most affected are late-stage start-ups, which are closer to public listing. The last thing that they want to face is a down-round. To avoid this, some of them are waiting and eliminating new deals. Moreover, investors are no longer so open to take riskier opportunities, since they cannot count on other investors to help them turn it into a success.
Furthermore, many pension funds and endowments are reducing their exposure to venture capital, because of the hit of public markets. They are allocating their investment into different asset classes. Since venture capitalists raise money from limited partners on a regular basis, maybe we are entering the times when spending will be slower. As The Economist mentioned, maybe a cash that took one year to spend will now be made to last around three times longer.
General partners need to make a “capital call” to be able to finance an investment. In this time, when it isn’t so easy for Limited partners to free up cash, GPs stand in front of a dilemma. Either they will push placing calls and risk the stability of their relationship with their investors, or they will do what some investors did in 2001, during a dot-com crash, when they gave back the already committed investment to some of their LPs to let them reallocate the money as they want and so save the relationship with investors to be able to fundraise in the future.