The venture capital market is showing early signs of weakness.
While market turmoil hasn’t yet affected deal sizes and valuations across all stages of venture capital, the average late-stage pre-money valuation has decreased from 2021’s highs, according to PitchBook’s VC Valuations report released Thursday. Specifically, the median late-stage VC deal size dropped from $134 million in 2021 to $110.3 million by the end of the first quarter of 2022.
PitchBook analyst Kyle Stanford, the author of the report, wrote that the decrease in late-stage valuations points to a potential problem: While deals are still closing, the transactions with the highest valuations are the most vulnerable to macroeconomic issues such as inflation, rising rates, geopolitical uncertainty, and the technology bubble. That’s because these companies are typically closer to the public market and tend to feel the effects of economic problems before other companies.
“VC is facing the onslaught of economic headwinds that are plaguing every other market at the same time, and for many reasons this feels like a true market shift,” Stanford wrote in an e-mail. “Valuations should come down, and deal sizes will likely retreat from the highs of the past couple [of] years.”
While median deal sizes contracted from 2021 to the first quarter of 2022, Stanford noted that it will take some time — possibly not until later in the year — before macro issues fully filter through to data. However, he also noted that the VC market has a few tricks up its sleeve to protect itself from public market volatility. For instance, there’s a massive amount of dry powder in mega-funds. PitchBook cited a total of $100 million or more in dry powder that is prepared to fund late-stage deals.
Another positive is the sheer number of venture funds in the market and the fundraising that will occur throughout the year. Stanford said that since the beginning of 2020, nearly 2,000 venture funds have been raised in the U.S. “That’s more than [the number that] closed in the seven-year period from 2006 to 2013,” he said. “Even though we expect fundraising to slow through the back half of 2022, the market is looking at somewhere around 3,000 funds still within their investment period.”
For this reason, late-stage companies could enjoy a soft landing, especially if they’ve raised capital in the past few quarters, when the market was booming.
Here’s some evidence. While initial public offerings did not provide the same opportunities as they did in 2021, valuation step-ups (that is, an increase in a company’s pre-money valuation between two funding rounds) at exit remained high in the first quarter. The report said that the median step-up for the first quarter of 2022 remained one of the highest in PitchBook’s dataset.
While late-stage exit valuations decreased from 2021 to 2022, median valuations at exit reached $90 million in the first quarter, a $14 million increase over any full-year figure in PitchBook’s dataset. This is significant because while some companies exit at higher valuations, many more exit closer to the median valuation.
“Continued headwinds may depress this figure,” Stanford wrote, “but for now, the core of the VC-backed exit market has continued to produce.”