Record-Setting Venture Capital Market Shows Signs Of A Slowdown

When pandemic-induced lockdowns started to spread in March 2020, partners at some venture capital firms became concerned about an overdue correction. Instead, the opposite happened, and the pandemic pushed the market into one of the strongest bull periods on record. Now, amid a geopolitical crisis and a downward-trending stock market, some in the industry say the overheated venture capital climate is finally beginning to cool down.

Investors tell Forbes that late-stage deal activity — which set records for both deal count and investment volume in 2021 — has slowed considerably over the past few weeks. They say that crossover investors who helped drive the breakneck pace in 2021 may have overindulged at the late stages. The broader venture ecosystem is realizing the swollen price tags they were willing to buy into to get into the hottest deals of 2021 were inflated, these investors say. And while the change so far has had the biggest impact at the late stage, the pullback is rippling down to Series A startups as well, they say.

A return to fundamentals is evident in board meetings, says Loren Straub, a general partner at B2B seed-focused Bowery Capital. The meetings she attends have new emphasis on hitting financial metrics before going out to raise rounds, she says. While that might delay some founders from raising on the schedule they concocted last year, more of an emphasis on profitability isn’t exactly a bad thing either, Straub says.

“How much can we back up with numbers and data that we have product market fit? All these things that can signal and de-risk a business are becoming that much more critical,” Straub says. She says companies looking to raise their Series A can still get good multiples now too. But instead of the 70x-80x that was common in 2021, they’ve returned to normal: 10x-20x. She adds that she knows of three startups looking to raise Series B rounds right now that are targeting multiples lower 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 with January, the first such dip in years. Late-stage funding was down 19%, from $41 billion to $33.2 billion, and more insulated early-stage funding also slipped 17%, from $18.4 billion to $15.3 billion. But these numbers are being compared to records. Even being down $10 billion, February 2022 still topped February 2021 by 24%.

Valuations have also begun to decline. Philadelphia-based dbt Labs, which creates an open-source data analytics tool, raised $222 million at a $4.2 billion valuation in February. While a big boost from the $1.4 billion valuation the startup raised at in June 2021, it’s less than the $6.2 billion the company originally sought, as Forbes reported at the time. (Cofounder and CEO Tristan Handy told Forbes that the company could still have raised at $6.2 billion if it wanted to but instead chose to raise at a lower valuation to protect employee stock options.)

While funding and valuations are trending down, investors say there is no reason to panic and this might be a needed respite. “It takes a while for founders, boards, employees to adjust from what they think they are worth,” Eric Paley, a partner at Founder Collective, tells Forbes. “It was probably the greatest multiples expansion in tech ever over the last few years. It’s hard to get people off those expectations.”

Mark Goldberg, a partner at Index Ventures, says that some of the pullback is due to fund logistics. Many firms increased their pace last year to keep up with the market’s speed, but that doesn’t change the set investment periods their funds are on or the amount of investments they told LPs they would be making. They might be pulling back just to balance out, he says.

Paley says that the market should enjoy the period of calm. He describes the past two years as the market being on its toes, leaning forward into the stories and the dreams of the entrepreneurial pitches they are hearing. It hasn’t dropped back to its heels, he says, but rather onto the balls of its feet.

“It would be reasonable to say that as much as the public market is going down it is still relatively aggressive compared to historical multiples,” Paley says. “It’s coming more in line with historic multiples. It’s not even at the historical norm.”

Both Paley and Goldberg say that exiting last year’s environment that prompted founders to consistently raise as funds banged down their doors, is actually a good thing. Paley called the constant fundraising “inefficient entrepreneurship” and Goldberg says not having that pressure to constantly raise means founders will be able to actually focus on building their companies.

But all three agree, good companies will still be able to raise this year with little to no problems if the trend continues as is. U.S.-based venture funds alone raised $128 billion last year and have plenty of powder to deploy. It will just depend a lot more on business economics than on a company’s 2021 growth story.

“I think for the top 5% or 10% of companies, nothing changes from last year,” Goldberg says. “If you are an exceptional business you are unaffected by the macro conditions.”