Is the liquidity crunch caused by the slow pace of startup exits hurting fundraising for venture capitalists?
Recent data on the second quarter makes that a somewhat easy theory to support, given that fewer startups are being bought out or going public, and VCs are raising new capital at a slower pace than in the past five years or more.
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According to first-look data from PitchBook, venture capitalists in the U.S. raised $33.3 billion through the end of Q2 2023. That figure pales in comparison to records set in 2021 and 2022, when venture investors raised more than $160 billion each year. If the pace set in Q1 2023 persists, the $66.6 billion that VCs would raise this year would be about 60% less than the peak levels we’ve seen in recent years.
At the same time, startup exits in the U.S. have cratered. In 2017, the U.S. had just over $100 billion worth of startup exits, per PitchBook. That number rose by a fourth or so to $128 billion in 2018.
Then things got hot: Startup exits reached nearly $250 billion in 2020 and a staggering $777.2 billion in 2021.
That last figure is such a massive outlier, we may not see it again for some time.
However, the value of startup exits has come back to earth now, totaling nearly $76 billion in 2022 and just $12 billion through the second quarter of this year. That final figure is a pittance compared to what we were seeing less than two years ago.
Clean correlations are rare in complex systems, but we can make some general points to help us understand the numbers:
- There is a positive feedback loop between startup exits and venture capital fundraising: Hot markets attract more dollars, and big exits make venture capital even more attractive.
- This is likely why venture exits peaked in 2021, but venture fundraising did not reach its zenith until 2022. Big returns led to even bigger funds — for a time, that is.
- But when exit volumes fell dramatically and it became clear that startup valuations would need to be adjusted to match the climate, venture fundraising tumbled as well. There are therefore fewer new dollars in the ecosystem, cementing the current focus on reducing costs and extending cash balances.
That’s not the whole story. Some venture investors could easily be sitting atop massive funds that they raised during boom times and haven’t fully deployed yet, lowering their need to raise new funds. It was relatively easy to raise oceans of capital when the startup market was on the climb, but as dealmaking slows down, it stands to reason that some VCs are simply not ready to raise more.
Many startups also raised way more cash during the boom than they needed to, and so can fund themselves for longer than they could have been expected to a decade ago. Their ability to stay alive could be partially precluding the demand for deals and limiting exit volume.
Call it a cash hangover.
That said, no matter how much we try to shine up the numbers, it’s clear that startup exits are close to a standstill. Because of that massive decline in liquidity, venture funds are sitting longer on stakes that may not be thriving. Who wants to pour more capital into an investing cohort that has not demonstrated the ability to recoup investments that it made years and years ago?
The situation will not resolve overnight, but a few more big exits could go a long way to brighten up 2023. So far, this year has trended toward the lowest dollar value of domestic startup exits since 2016, a figure similar to what we saw back in 2011. Given how much bigger venture capital is today compared to those years, we’re looking at a catastrophe in the making.
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