Somehow, some way, the third quarter is nearly over. That means we’re gearing up for a wave of venture capital data that will start to drop in less than two weeks’ time. We’re itching to get our hands on the final numbers because the third quarter of 2022 is a pretty damn important data point.
Why? Because Q1 2022 was replete with deals that got started back in 2021, when venture economics were spitting out very different valuations and deal sizes than we see today. The second quarter was similar, in that it was not a fully decelerated period. (Y Combinator’s Michael Seibel noted in a recent interview that it wasn’t obvious how slow things were going to get until April or May.)
But the third quarter should present us with a picture of the global and regional venture capital markets that has no 2021 overhang and none of the lingering enthusiasm we saw in early Q2. So we have some questions — just like last year.
To help frame our questions, we pulled preliminary data. It doesn’t look good.
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Per a quick and dirty PitchBook query, venture capital activity in the United States is set to slow dramatically in Q3 2022, from $70.8 billion invested in the second quarter across 3,972 deals to what is currently tabulated as $37.87 billion invested in 2,424 deals. Recall that U.S. venture capital activity peaked in Q4 2021, when it was worth some $94.7 billion.
Europe is similar, with Q2 2022 bringing $47.53 billion in 2,709 deals. Europe’s Q3 tally adds up to $24.53 billion across 1,669 deals, per PitchBook data this morning. Europe’s record haul? Q1 2021, when around $58 billion went into the region’s startups. Things have slowed — and are slowing further.
With that context in hand, here’s what we want to determine when we get the final figures in.
Did leading markets decelerate faster than smaller markets?
We pay more attention to large venture markets than small ones. It’s not hard to tell why — larger markets mean more is going on, and as a news publication, that’s where our attention is pulled. But we also make time for smaller regions of startup and venture capital activity because they matter, too.
One theme we noted in our Q2 2022 reporting was that some upcoming startup markets were performing better than their larger peers. Africa is perhaps the leading example here, with this column noting that “data indicates that Africa is not only posting year-over-year gains in venture capital fundraising — it could also be on track for a record year.”
Naturally, smaller venture capital markets are more swayed by big one-off deals than their larger peers. Still, seeing line go up in Africa took us by surprise; after all, you might think that less mature markets for startup formation and investment would take a slowing economy harder than their more mature siblings.
So: What happened in Q3 regarding the relative pace changes in large and small startup markets and why? That’s something we really want to figure out.
What is the startup valuation disconnect that held back deal flow?
Back to the U.S. and major markets: It’s hard to tell what caused deal flow to slow down as much as it did this quarter. Chances are there are multiple factors at play. But there is one hypothesis that we find particularly interesting: That (some) VCs are just waiting it out.
But what are VCs waiting for, exactly? At first, we believed that they might be giving a bit of time to founders to accept that their startups are a lot less valuable than they initially thought. But according to Upfront Ventures’ managing partner Mark Suster, this might be a lost battle.
In a blog post, Suster explained that investors he knows are “waiting for a cohort of founders who aren’t artificially clinging to 2021 valuation metrics,” adding:
I talked to a couple of friends of mine who are late-stage growth investors and they basically told me, “we’re just not taking any meetings with companies who raised their last growth round in 2021 because we know there is still a mismatch of expectations. We’ll just wait until companies that last raised in 2019 or 2020 come to market.
It will be difficult to figure out from Q3 data alone whether it’s indeed overrated valuations that are slowing down deal flow. But when we get numbers for the full year, we will be able to validate Suster’s take if deal flow does pick up in the last quarter while median valuations keep declining.
How many mega-deals did we see, and where did they go?
Ah yes, the nine-figure venture varietal that everyone either covets or raises. Mega-rounds, or deals worth $100 million or more, are standard unicorn fodder, in that we tend to see the most valuable startups raise them. But with unicorn formation slowing rapidly and overall deal value expected to tumble in Q3 2022, what happened to the formerly common nine-figure venture capital round in Q3?
Our expectation is that it slowed, perhaps in line with other venture capital stage types. But this may not be correct. Why? The sheer number of existing unicorns in the market, crossed with a slowing exit market. The combination, you might think, would necessitate lots of huge venture rounds to keep those companies, well, alive.
Naturally, our notes above regarding valuation imply that we could see many a unicorn lose its horn when they raise again, but that won’t happen to all of them, and because effectively none are profitable, they will need cash.
If huge deals decelerated in Q3, then we could see the onset of unicorn starvation, where the only solution is a massive valuation cut to raise private capital, or hopes that the IPO market returns quickly and becomes more welcoming to 2021 startup prices. In short, the number of mega-rounds we count up in Q3 should help us understand how many billion-dollar startups are in big trouble, perhaps even soon.
After all, M&A can’t make up the IPO deficit and cover up for rapidly decelerating mega-round activity, right?
Were there more M&As?
The IPO deficit isn’t news. We already wrote quite a bit about public exits being frozen — whether it’s SPACs or regular IPOs. But we now have more data on the latter: Based on data from Morgan Stanley, the Financial Times noted that tomorrow “will mark 238 days without a tech IPO worth more than $50 million.”
As much as we are starting to hate the word, such a dearth of IPOs is unprecedented. According to the FT and Morgan Stanley’s research, such a length of time without major public exits surpassed “the previous records set in the aftermath of the 2008 financial crisis and the early 2000s dotcom crash.”
No IPOs should logically result in more M&As. Even more so when there’s a valuation mismatch, meaning that founders and VCs just can’t agree on price. But were there really more M&As in Q3 than in the first half of the year?
That’s what we’d love to find out. After all, there are reasons why it might not have happened, such as the fact that private equity funds and corporations aren’t exactly fond of price uncertainty, either.
How low did China go?
What investors like even less than price uncertainty is macro uncertainty. But when it comes to China, it’s what they have been served. Not just because of international geopolitical tensions but also because of national issues around tech.
As we’ve reported, some parts of tech have simply fallen out of favor with the Chinese Communist Party, leaving some previously promising giants struggling. And the rise of other verticals doesn’t seem to make up for it: At the end of August, we looked at data from the Global Private Capital Association, showing that private capital activity in China was 37% lower in the first half of 2022 than during the same period of 2021.
Did China’s tech sector recover during Q3? We doubt it — but we wouldn’t mind being wrong.
That’s what’s top of mind. Of course, we’ll follow where the data leads, but we are more than stoked to at least get the above questions answered in short order. The Exchange and TechCrunch+ are going to be all over the numbers. Stay tuned.