You might think given the chatter in the startup world that venture capitalists are short on funds — after all, we’re hearing about young tech companies finding themselves marooned between stages, hitting up investors with smaller capital pools than prior backers and turning to equity crowdfunding to keep their cash balances healthy.
And yet new data from PitchBook and the National Venture Capital Association indicate that while the pace of U.S. venture capital investment is slowing — more here on the global perspective — American venture capitalists are sitting atop more investable capital (dry powder) than ever before.
Even more, the pace at which venture investors are accreting funds is elevated compared to historical norms, meaning that private-market investors are in aggregate not struggling to raise, even if their portfolio companies may find themselves in a very different situation.
The question bouncing around our minds this morning is why — why are venture investments slowing when so much capital has been raised by VCs to invest?
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Dry powder
If venture capital fundraising held steady, and the pace at which VCs put funds to work slowed, we’d expect to see dry powder pile up. However, even during the boom times of late 2020 and 2021, venture capitalists stockpiled more investable cash. Per PitchBook data, venture capital raised but not disbursed — what it calls “U.S. VC capital overhang” — reached $198 billion in 2020, $234 billion in 2021 and $290 billion at the end of the second quarter of 2022.
Not only are venture capitalists stacking more spare cash, but they are doing so at an increasingly rapid clip, at least through the first half of this year.
Why then the decline in funding totals if venture accounts are metaphorically straining at the seams? PitchBook makes an interesting observation that may provide some context. From its report:
$290.1 billion in dry powder has been amassed by the VC market in the U.S., with much of that stored in mega-funds of $500 million or larger.
A bit like how we saw mega-rounds command a huge portion of the value of the venture capital market in recent years, it appears that the largest funds are doing the heavy lifting of raising capital today. Why does that matter? Because the rounds that the largest funds traditionally invest in — the largest rounds, naturally — are seeing a pullback of sorts.
PitchBook notes that following “a record Q1, Q2’s number of closed late-stage deals declined just over 10%,” which makes the pullback in question seem rather modest. But the size of late-stage deals is falling this year, meaning that the actual number of dollars invested in the later startup stages is slowing twice — once in terms of deals and second in terms of the value of those investments, both individually and in aggregate.
This explains a good bit of the dissonance between rising venture dry powder and the market as we see it today from a fundraising perspective; late-stage investors are raising the most, and those same investors are perhaps those most in the driver’s seat when it comes to holding onto chips for later play.
This is not surprising; last year, the late-stage markets went nuts, with record numbers of mega-rounds, new unicorn births and the like. Funds raised thus far in 2022 might have been sized to those investing conditions. Now that the market has swung from FOMO to JOMO, the funds targeting the largest deals — the most expensive deals in round size and valuation terms — might also be the most price sensitive.
After all, the later-stage a startup is, the more responsive its value is to changes in the public markets, and stocks have fallen, meaning that many companies that could have raised large checks at new, higher prices this time last year are far from able to do so today.
In a sense, then, the rising pace at which venture investors are hoarding pledged investment cash is predicated on the fact that many startups are sitting on valuations that no longer match reality. VCs and founders are stuck on opposite sides: Founders in charge of overvalued late-stage startups that need cash are on one end and venture investors sitting on cash but uninterested in investing in overvalued late-stage startups are on the other.
The obvious solution is for unicorns to take stiff valuation cuts, making their equity more attractive to investors and breaking the logjam that we see in the data. But ironically, the same investors busy not piling into the portfolio companies of other investors likely don’t want to see their own portfolio companies — companies that need other investors to bite — revalue themselves in a manner that will undercut their fund performance data.
The cliché about rocks and hard places comes to mind.
Investors got greedy last year, betting that rapid-fire investing would lead to massive returns. Instead, those investors often bought paper returns, investing results that this year appear shaky. Today, we’re in a more fear-first investing climate, pulling venture capital from underneath the very companies that the investing class was most enthused about last year. Irony? Sure, but that’s little comfort to founders.
What’s the possible good news? If the public markets stop shedding value, and perhaps even show a modest sign of life, we could see late-stage investors with lots of capital more willing to invest. If that happens, there is capital ready to go. All startups need is for the narrative around their worth to improve a little and the capital dam could break.
But a potential wave of liquid cash is worth precisely zero to a startup that needs money now. And that startup might die of capital thirst while the very investing group built to fund its work is packing extra supplies. To put it in terms of U.S. water supplies, startups are Arizona, and venture investors are the Columbia River.
The latter has what the former needs. If only they weren’t so damn far apart.
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