When the pandemic-induced lockdowns began to spread in March 2020, partners at some venture capital firms began to worry about a long-overdue correction. Instead, the opposite happened and the pandemic pushed the market into one of the strongest bull runs on record. Now, amid a geopolitical crisis and a downtrend stock market, some in the industry say the overheated venture capital climate is finally starting to cool down.
investors count Forbes That late-stage deal activity, which set records for both deal count and investment volume in 2021, has slowed considerably in recent weeks. They say the crossover investors who helped fuel the blistering pace in 2021 may have overdone it in the later stages. The broader venture ecosystem is realizing that the bloated price tags they were willing to buy for the best 2021 deals were inflated, these investors say. And while the change has so far had the biggest impact late-stage, the pushback is also spreading to Series A startups, they say.
A return to fundamentals is evident at board meetings, says Loren Straub, general partner at Bowery Capital B2B focused on seeds.. The meetings he attends have a new emphasis on hitting financial metrics before going out to raise rounds, he says. While that might delay some founders from raising funds on the schedule they laid out last year, a greater emphasis on profitability isn’t exactly a bad thing either, Straub says.
“How much can we support with numbers and data that we have a suitable product for the market? All of these things that can pinpoint and reduce risk to a business are becoming much more critical,” says Straub. She says that companies looking to raise their Series A can also get good multiples now. But instead of the 70x-80x that was common in 2021, they are back to normal: 10x-20x. She adds that she knows of three startups looking to raise Series B rounds right now that are targeting lower multiples than their Series A rounds despite solid growth and increased traction since their last raise.
Recent data from Crunchbase shows that global funding is down. Startups raised $10 billion less in February compared to January, the first such drop in years. Late-stage funding decreased 19%, from $41 billion to $33.2 billion, and more isolated early-stage funding also fell 17%, from $18.4 billion to $15.3 billion. But these numbers are being compared to the records. Even down $10 billion, February 2022 still beat February 2021 by 24%.
Valuations have also started to decline. Philadelphia-based dbt Labs, which creates an open-source data analysis tool, raised $222 million at a $4.2 billion valuation in February. While that’s a big boost from the $1.4 billion valuation the startup raised in June 2021, it’s less than the $6.2 billion the company was originally seeking, as Forbes reported at the time. (Co-founder and CEO Tristan Handy said Forbes that the company could still have raised $6.2 billion if it had wanted to, but instead chose to raise at a lower valuation to protect employee stock options).
While funding and valuations are trending lower, investors say there is no reason to panic and this could be a needed respite. “Founders, boards, and employees take a while to adjust to what they think they’re worth,” says Eric Paley, partner at Founder Collective. Forbes. “It was probably the biggest expansion of multiples in technology in recent years. It’s hard to get people out of those expectations.”
Mark Goldberg, a partner at Index Ventures, says part of the pullback is due to fund logistics. Many companies stepped up their pace last year to keep up with the speed of the market, but that doesn’t change the set investment periods their funds are in or the number of investments they told LPs they would make. They could be backing up just to balance, he says.
Paley says that the market should enjoy the lull. He describes the last two years as a market on its toes, leaning forward on the stories and dreams of the business speeches they’re hearing. He hasn’t landed on his heels again, he says, but rather on his toes.
“It would be reasonable to say that as much as the public market is falling, it is still relatively aggressive compared to historical multiples,” says Paley. “It’s closer to historical multiples. It’s not even in the historical norm.”
Both Paley and Goldberg say breaking out of last year’s environment that prompted founders to steadily raise money while funds pounded on their doors is actually a good thing. Paley called constant fundraising “inefficient entrepreneurship,” and Goldberg says not having that pressure to constantly fundraise means founders will be able to really focus on building their companies.
But all three agree, the good companies will still be able to ramp up this year with little to no problems if the trend continues as it is. US-based venture funds alone raised $128bn last year and have a lot of dust to roll out. It will simply depend much more on business economics than on a company’s growth story in 2021.
“I think for the top 5% or 10% of companies, nothing changes from last year,” says Goldberg. “If you are an exceptional business, you are not affected by macro conditions.”