The VC Market Feels the Burn of the Downturn

With quarterly lows in dealmaking and fundraising, the venture capital market is proving not to be immune to the shocks of a declining public market.

Still, while venture capital deal activity buckled under the weight of the wider economic downturn in the third quarter, deal count remained high on a historical basis, and U.S. VC fundraising set a new annual record at the end of the quarter, according to preliminary data from the PitchBook-NVCA venture monitor. The full report is set to publish next week.

Despite these historical highs, the third quarter marked the lowest deal count since the fourth quarter of 2020, and estimated deal count fell around 20 percent from the first quarter’s record high. Capital invested across VC deals totaled $43 billion, a nine-quarter low. 

While 2022 has been a challenging macroeconomic year, last year’s exceptional performance across all fronts was bound to come back down to earth at some point, according to Kyle Stanford, lead venture capital analyst at PitchBook. “I think it’s still getting lost that 2021 was such an outlier year,” Stanford told Institutional Investor. “We were looking at a market that was more active in the past 18 months than we’ve ever seen before, and so it’s natural for that market to slow down, especially when we come up on some uncertainties.” 

While dealmaking suffered, venture capitalists set a new annual record for fundraising. VC funds have raised a total of $150.9 billion as of the third quarter, beating last year’s high — despite a steep decline in fundraising in the third quarter.

Stanford said the majority of this year’s record fundraising numbers occurred in the first two quarters, which he attributed to investors tying up loose ends and closing funds that they started when the market was hot. Much of the capital recorded for funds closed in 2022 likely came from commitments made in 2021, he said.

And Stanford expects fundraising will continue to slow: “Public markets are still incredibly low compared to where they have been, which is going to depress the public portfolio of the [limited partners] that are making commitments to VC,” he said. 

Because of this decline, LPs will find their portfolios over-allocated to VC — a phenomenon known as the denominator effect. This typically deters allocators from putting more capital into VC and other private assets.

According to PitchBook, the third quarter also saw a low total exit value at around $14 billion. For reference, the second quarter of 2021 saw $266.8 billion in total VC exit value.

Given the current pace of exit activity, PitchBook warned that annual exit value may fall below $100 billion for the first time since 2016. Stanford said overall fundraising value could take an even bigger hit as a result.

Despite the challenges facing the asset class, Stanford said that early-stage, median-sized deals are going strong and remaining at or near their all-time highs of 2021. “What that tells me is that investors and LPs are still viewing the private markets as an area to continue putting money into, even in a downturn,” he said.