If you thought that the recent venture capital market was tough, let me tell you about 2016, 2017, 2018, 2019 and 2020.
With the first week of December under our belts, we’re not too far away from the end of the year. That means that 2022’s venture capital story has largely been written. It’s not a single narrative; instead, this year started on a high, with momentum from the monstrous 2021 funding period persisting into the new year. From that point, we’ve seen a slowdown accelerate into what some consider a downturn.
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Startups raised lots of capital this year. Less, yes, than last year, but more than in nearly any year in recent memory. It’s still a good time to build a tech upstart.
Does that perspective feel too sunny when we hear so much doom and gloom on Twitter regarding startup prospects in a more conservative investing climate?
A recent dataset backs up our perspective. Cooley, a well-known legal group in the U.S. startup scene, releases metrics on deals that it works on regularly. Its Q3 report — dropped a few days back — includes an interesting factoid that made us reconsider just what sort of year startups really had.
It appears that down rounds, while up from near extinction last year, remain depressed compared to even recent history.
By that, we mean that startups today are far less likely to raise a down round, at least through Q3, than they were in other years that were not considered weak at the time. We’re a bit spoiled, in other words. Into the data!
An uptick in down rounds
Cooley data, segmented to just technology rounds to clarify the picture, indicate that 10% of rounds that it saw in Q3 2022 were raised at a lower valuation mark than their preceding round. That’s a lot compared to recent periods, with down rounds coming in the low single-digits for much of 2020 and 2021; for several quarters in late 2021 and early 2022, the figure hovered between 1% and 2%.
So, sure, compared to that, yes, a 10% rate of down rounds is a 5x to 10x jump in frequency. You are going to feel that.
At the same time, we’ve seen higher rates of down rounds. The second quarter of 2020, for example, saw around 17% of Cooley-assisted rounds secure down valuations. (Cooley notes in the digest of its data that PitchBook rates it as the most prolific law firm in deal-count terms, so it has standing when it comes to the data it shares.)
“But that was the onset of the pandemic in the United States!” I can hear you protesting. A fair point! So let’s go back in time. Down rounds represented 14% of Cooley’s deals in Q1 2020, 13% in Q3 2019, 10% in Q4 2018 and 12% per quarter from Q4 2017 through Q2 2018. That figure ticked above 20% in a few quarters in 2016 and 2017.
There are lots of recent historical examples of down rounds taking on far more share than what we saw in the third quarter of 2022, a period that, I think it’s fair to say, most expect to shake out as more active than the present Q4. The data is recent, therefore, and representative.
Down rounds, if they continue their current upward trajectory as a fraction of all venture deals, could return to prior heights in a few quarters. But through the onset of October, they just weren’t that bad comparatively. Perhaps we all let 2021 change our definition of “normal” a bit too much.
The real bad news
Down rounds are a massive bummer, everyone knows. They can turn normal-looking cap tables into messes if investors in prior rounds had anti-dilution protections baked into their stakes. But there are other signals in the market that we track to understand how the venture market is evolving.
Late-stage valuations are one such signal. The Cooley dataset through Q3 indicates that Series D+ valuations in August and September, measured on a median, pre-money vector, fell to monthly levels not seen since August 2020. (This particular set of data is a bit laggier than the other bits that Cooley has on offer, but it remains interesting.)
Series D rounds and those that come after are somewhat rare, so the data we are looking at in this context is highly variable. Still, parsing the information shared, it is clear that super late-stage valuations are sharply lower in the back half of 2022. Not a surprise, but the downscaling of the potential value of Series D and later startups means that there is, we presume, less value to generate early on in a startup’s life. That means more dilution for founding teams and, frankly, less room to raise huge chunks of capital.
That’s more worrisome than a modest uptick in down rounds, we reckon, given the sheer number of unicorns in the market. The September pre-money median valuation for a Series D+ round that Cooley saw was around $650 million. That’s under the unicorn bar. Oof.