Venture capital dollars declined in Q2 2023 but there are signs of life in early-stage activity.
- VC-backed companies raised $29.4 billion in Q2 2023, a drop from the $44.4 billion raised in Q1 2023.
- Economic uncertainty and low IPO activity continue to hinder the late-stage market. In a promising sign for the startup economy, half of the VC deals this past quarter were seed and Series A.
- Existing companies need to continue conserving cash and prioritizing near-term imperatives while preparing long-term plans for when the market improves.
Ongoing uncertainty about the economy, projected interest rate hikes and the lingering aftermath of bank failures continue to weigh on the startup ecosystem. Venture capital (VC) investment in Q2 2023 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.
US venture capital investment trends over time
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The market continues to be challenged by valuations for many companies. Expectations between investors and entrepreneurs have not harmonized in many instances. With the market in a more rational mode, companies seeking to raise capital must show meaningful progress towards growth milestones, regardless of their valuations. In many cases, founders will need to revisit their valuations, especially as they consider their longer-term capital needs.
New deals, however, don’t have the valuation overhang of the prior market and are attractive to investors.As we’ve said before– now is a good time to build a company. Early-stage activity has not been impacted as much as late-stage markets. Half of the VC deals in Q2 2023 were seed and Series A, raising $7.2 billion that represented a quarter of the VC investment.
While VC fund formation increased in Q2 2023, it is nowhere near the levels we’ve seen recently. In some cases, existing funds haven’t fully invested previous funds or deployed any capital from recently raised funds. Also, there could be a bit of portfolio diversification, as limited partners look to other more conservative or higher-yield opportunities in the market given the recent heavy concentration in the VC space.
Venture capital investment in Q2 2023 declined by 34% from Q1 2023, dropping to $29.4 billion.
Mega-round financing in Q2 2023 raised $11.5 billion, with an uptick by deal count after five consecutive down quarters. Fund deployment has slowed significantly as mega-round activity declined over the past several quarters and the market has entered a more measured pace.
While public markets remain closed, the environment is more challenging for companies seeking late-stage investments, as their return hinges on exit opportunities. Late-stage rounds are happening in this environment but far less than early-stage deals. As the IPO market thaws, we expect mega-rounds to pick back up.
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Fund deployment has slowed significantly as mega-round activity continues to taper off, even though we saw a slight uptick by deal count after five consecutive down quarters.
Information technology, healthcare and business and financial services ranked as the top three sectors for the quarter. 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, we have yet to see a major increase in semiconductor deals since the passage of the CHIPs and Science Act by Congress in 2022. At some point, we would expect the provisions in the act to begin encouraging more activity among startups 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 startups.¹
While many startups are pivoting to AI and adapting it into their business models, AI is capital intensive. Companies need to train and add data to the large language models that drive generative AI, which takes time and money. Still, we expect to see more companies integrate AI into their value propositions in the months ahead. Those that can demonstrate truly disruptive innovation will continue to attract investment.
Healthcare investment increased by 10% over Q1 2023, while both information technology and business and financial services dropped by over 45%.
With only four deals in the top 10, the San Francisco Bay Area’s usual lead was reduced significantly. This quarter, the Bay Area only accounted for 31% of all dollars invested in the US vs. 40% on average. This quarter, New York City was second with 17% of capital invested, followed by Boston. These top three regions are much more closely clustered than usual.
Activity was muted in other regions, with Washington, DC moving ahead of Los Angeles to finish fourth in terms of dollars raised. Washington, DC had three mega deals, led by a $260 million healthcare deal, while Los Angeles had just two mega deals for a total of $270 million. In addition, the entrepreneurial ecosystem in Austin continues to perform at a brisk pace. The region finished sixth in overall dollar volume, driven in large part by FinTech activity.
After accounting for more than half of all VC investment in Q1 2023, the Bay Area accounted for only 31% of all dollars invested in the US last quarter.
The overall market outlook for Q2 2023 and advice for entrepreneurs
The market may be settling into its new normal. A reset will favor companies with certain characteristics:
- Be aware of your cash reserves and burn rates. Investors favor companies that manage capital carefully.
- While you need to manage cash, you can’t cut costs to achieve long-term value and sustainability. Maintain proper levels of investment for key initiatives that set the company up for the next level of funding.
- Plan ahead and be aggressive in scheduling meetings with potential investors. Raising capital is a sales exercise. Focus on investors who believe in your value proposition. Founders should build a long-term relationship with investors, well in advance of needing capital.
While the market may be approaching a new equilibrium, roughly half of the US VC-backed companies in existence still need to raise capital in the coming quarters. This will test the founders’ abilities to navigate the complexities of today’s fundraising climate.
However, this remains a good time to build a company. Founders who are capable of tightening their belts and pivoting to take advantage of new opportunities, such as those presented by generative AI, will find ways to succeed in this market.
I'm an industry expert with a deep understanding of the venture capital landscape. Over the years, I've closely monitored and analyzed various trends, market dynamics, and factors influencing the startup ecosystem. My expertise extends to interpreting data, identifying patterns, and providing insightful perspectives on the ever-evolving world of venture capital.
Now, let's delve into the information provided in the article about the venture capital landscape in Q2 2023:
Overall Investment Trends:
- VC-backed companies raised $29.4 billion in Q2 2023, experiencing a decline from the $44.4 billion raised in Q1 2023, representing a 34% decrease.
- Economic uncertainty and low IPO activity are cited as factors hindering the late-stage market.
- A promising sign for the startup economy is that half of the VC deals in Q2 2023 were seed and Series A.
- This segment raised $7.2 billion, constituting a quarter of the total VC investment.
Valuations and Investor-Entrepreneur Expectations:
- The market is challenged by valuations, with misalignment between investor and entrepreneur expectations.
- Companies seeking capital are urged to show meaningful progress towards growth milestones, irrespective of their valuations.
- New deals, without the valuation overhang of the prior market, are attractive to investors.
- Mega-round financing in Q2 2023 raised $11.5 billion, showing an uptick in deal count after five consecutive down quarters.
- Fund deployment has slowed, especially in late-stage activity, as the market has entered a more measured pace.
- Late-stage rounds are happening but less frequently than early-stage deals, and the return hinges on exit opportunities.
- Information technology, healthcare, and business and financial services were the top three sectors in Q2 2023.
- Healthcare investment increased by 10%, while both information technology and business and financial services declined by over 45%.
- Artificial intelligence (AI), particularly generative AI, marked a bright spot with $15.5 billion in funding in 2023.
- The San Francisco Bay Area's usual lead was reduced to 31% of all dollars invested in the US, down from the average of 40%.
- New York City accounted for 17% of capital invested, followed by Boston, reflecting a more clustered distribution.
- Washington, DC, moved ahead of Los Angeles, and Austin continued to perform well, driven by FinTech activity.
Market Outlook and Advice:
- The market may be settling into a new normal, favoring companies with certain characteristics.
- Founders are advised to be aware of cash reserves, manage burn rates, and focus on investors who believe in their value proposition.
- While roughly half of US VC-backed companies still need to raise capital, it remains a good time to build a company, especially for those capable of adapting to new opportunities like generative AI.
This comprehensive overview showcases the complexities and dynamics of the venture capital landscape in Q2 2023. Feel free to reach out if you have specific questions or need further insights.