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Suddenly, venture capital firms that handed out more than 1 trillion dollars in investor capital in two years, investing in 30,000 deals, are signaling a two year drought.
Crunchbase recently reported that North American Startup Funding fell 63% in the fourth quarter compared to a year ago. And a CNBC story “Startup funding has tanked over the past year – and recession fears are to blame” also pointed out “if you’re among the large number of Americans hoping to quit your job and pursue a side hustle full-time, you may want to wait a while.”
But this funding plunge is far less stark and ominous than we might believe; the data tells us it’s simply a reversion to the mean for markets, with 2021 being an outlier. Fourth-quarter global VC investing, at almost $66 billion, was down 63% from the highest quarterly total ever: some $180 billion in the fourth quarter of 2021. And that Q4 total was up almost double from the funding level of the final period of 2020.
In the 10 quarters before the bubble (Q1 2018 through Q2 2020), VCs invested at an average quarterly rate of $67 billion. The new Q4 2022 total of almost $66 billion is nearly flat, less than 2% below that pre-bubble average.
By comparison, VC investing in 2021 was madness, driven by the Federal Reserve’s zero interest rate policies. Total bets were almost $640 billion, up more than double in just one year at $160 billion per quarter. In 2022, $415 billion total was invested, a quarterly average of more than $100 billion, and 55% more funding than the pre-bubble average, for the period between Q1 2018 and Q2 2020.
Thus, the new numbers show that the venture industry is returning to normal. Less growth-at-any-cost, less frenzy, less pumping up the volume and valuations in cynical certainty that the next bigger fool will buy you out at a tidy profit.
To be sure, this downturn has set off a shakeout and wreaked havoc on tech employees. Startups are laying off far more workers, pound for pound, than Big Tech—more than 100,000 layoffs in recent months vs. only 30,000 or so for large companies, as I wrote here.
Big Tech draws the headlines. Since the beginning of the new year, Microsoft
MSFT
AMZN
Layoffs at startups, meanwhile, draw less notice and have a more drastic impact. Flexport laid off 20% of its workforce, 640 employees, in January due to macroeconomic headwinds; Coinbase axing 950 workers this month, on top of 1,100 last June, amounts to 20% of staff; just 200 jobs cut at Roku is a 5% reduction.
It is okay, though: survival of the smartest and the slimmest. This, too, shall pass.
Some experts, competing to give the gloomiest forecast, argue that a deep recession is coming. They say VCs will hold back amid uncertainty, and startup companies will have to endure two years of winter with no venture funding forthcoming.
This may not be the case. The biggest reason of all: dry powder. VC firms have almost $300 billion in committed cash sitting idle. US private equity firms have another $1.1 trillion waiting at the ready. Dozens of sources at multistage VC firms and private equity funds say they are itching to get back to work. That money wants to grow.
It is a VC firm’s job to navigate uncertainty and invest in even the worst of times, when some of the most storied tech firms have arisen. When interest rates were at zero, they had tons of moxie; now rates at 4.5%, and somehow this is more than the fainthearted can bear?
Plus, I doubt a recession will be deep, if it arrives at all. The most important measure is job losses, yet new jobs were up by 223,000 in December, unemployment fell to 3.5%, and average hourly earnings rose almost 5% from a year ago.
The biggest economic worry has been soaring inflation, and it is down to 6.5% in December from a year earlier, a significant drop from a record-high 7.1% in November. Gas prices fell almost 10%, and Christmas sales were up nicely.
Recession? What recession?
The strongest young companies will survive this downturn by scrapping growth-at-all-costs to focus on hardcore business fundamentals, including free cash flow and “positive unit economics”—selling what you make for more than what it costs you to make it.
Once they learn how to do that, and the market improves, they will no longer need the VCs that let them down. Cash flow will be king.
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