By Joel Kranc
Economic uncertainty persists, especially as global conflicts rage; government shutdowns in the U.S. loom, and other geopolitical events unfold. This uncertainty has affected venture capital (VC) investment in Q2 2023, according to Ernst & Young, which says the market dropped to $29.4 billion, down from $44.4 billion in Q1 2023, a decline of 34%.
The decline isn’t as stark as it sounds, however. In Q1 2023, two mega-round deals accounted for $16.5 billion. This could point to the market finding a new equilibrium.
Though overall deal and exit activity tapered off to the end 2022, total U.S. venture fundraising for full year 2022 continued the record setting trend of prior years. Total dollar value of funds raised ($167 billion) beat the record set in 2021 ($160 billion).
However, according to Mercer’s Quarterly Alternatives Report, fundraising activity through 2023 has been quite low at only $33 billion. Total fund count declined approximately 33% year-over-year, implying that larger funds are driving recent fundraising activity, a similar theme with U.S. private equity. Total fund count through Q2 of 23 was 233.
Interestingly, the CVCA’s Canadian Venture Capital Market Overview shows that Canada has had a different trajectory. The second quarter of 2023 saw C$2.8 billion invested across 170 deals, with a total of nearly $4 billion raised across 335 deals in the first half of 2023.
The second quarter of 2023 saw a 140% rise in dollars invested and three percent rise in deal count quarter-over-quarter. This is a stark contrast from the US numbers.
But where are the investments going in these kinds of markets?
Information technology, healthcare and business and financial services ranked as the top three sectors for the quarter, according to Ernst & Young. Investment into healthcare increased by 10%, while both information technology and business and financial services declined by over 45%.
While software continues to lead the subsectors there is yet to be an increase in semiconductor deals since the passage of the CHIPs and Science Act by Congress in 2022. At some point, notes E&Y, there should be the provisions in the act to begin encouraging more activity among start-ups as well. This could contribute to a pickup in information technology investment, which encompasses computer software, networking and hardware.
Artificial intelligence (AI) — particularly generative AI — has marked one of the few bright spots in the VC space this year, as a driving force behind software’s lead among subsectors. So far in 2023, $15.5 billion in funding has been directed to AI start-ups.
But not all paths are rosy. In the summer of 2023, OMERS Ventures, the OMERS pension plan’s venture capital arm, said it was pulling out of Europe, marking a prominent global departure from the continent as EU technology investing dwindles. The venture unit had set up a $332 million fund in 2019 to focus on European start-ups.
“We have made the decision to shift our focus to North America because we believe it is best positioned to weather the current and future economic storms,” Damien Steel, OMERS Ventures’ global managing partner and head of ventures, said in a statement to the media.
In a report earlier this year, the Ontario Teachers’ Pension Plan said it estimates around 20% of the dry powder may be earmarked for infrastructure type investments, largely in the “climatech” space requiring large capital outlays for factories or carbon capture facilities, for example. While another 20% is likely non-conventional capital, which appeared in the past two years and will be much slower to re-engage.
“That leaves around $200B-$300B of dry powder available to deploy into the market. For most of 2021 and the first half of 2022, unicorns were raising $20B-$30B per month, so there is a risk that founders could be left high and dry,” says the report.
The CVCA says information, communications & technology sector is thriving attracting $2.4 billion across 162 deals, life sciences had $738 million in total deal value, cleantech saw $519 million and agribusiness grew with $165 million across 21 deals.
But VC is quite different than it was 20 years ago in the dot-com days, according to William Charlton, global head of Private Markets Data Analytics and Research with Mercer. “In those days, the common thing was having a first-mover advantage, which turned out to be absolutely no value because it’s not the first company that makes money but is the one that is best funded.” So, he says the real difference between now and then is that today we have real companies with clients and revenue. “The big issue today is valuation,” he adds.
He adds there is evidence that there are areas for VC funds to make money now even though the uptick of a few years ago has decreased somewhat. “A lot of companies are still valuable and have fundamental value in them,” notes Charlton.
“And,” he adds, “the most interesting companies get started when there is a downturn,” he adds. “When things go down in the venture market [generally] your stock holdings don’t have a lot of value so your opportunity costs for leaving and starting something new is lower. It’s a great time to invest if you believe technology is going to develop and offer new possibilities, going forward.”
Charlton also says institutional investors are making investment decisions based on markets of the future and should look at their liquidity requirements – but it is difficult to anticipate where those cycles would go if you are looking at future market predictions. As for some of the pullback in VC, Charlton says many institutional investors may want to commit to managers they like, or who have good track records, but “throttle back” the amount of the commitment as a way to mitigate risk and manage liquidity.
Overall, Charlton says the VC game is about time and the future of technology. “It’s not a cyclical bet, it’s a technology bet over a long period of time.”
