Reaching rock bottom
spelunker • \spih-LUNK-er\ • noun. : one who makes a hobby of exploring and studying caves.
Throughout history, spelunkers have explored the world’s deepest caves with the ultimate goal of reaching rock bottom. In late August 2017, the deepest known cave in the world was the Krubera Cave in the partially recognized state of the Republic of Abkhazia, which lies in northwestern Georgia. This was until a team of spelunkers discovered additional tunnels in the neighboring Veryovkina Cave, which resulted in a new record depth of 7,231 feet. The Veryovkina cave now has the official mantle of being the deepest explored cave to date (the team that discovered the cave narrowly escaped a flood from a rainstorm a year later when exploring even further).
The venture capital space is currently on a similar voyage of exploring new depths. As we explored in previous quarterly updates, 2022 was a challenging macroeconomic environment for the venture community. Climbing interest rates, soaring inflation, continued supply chain issues, and conflict in Europe created a perfect storm to end a decade-long bull market. Going into March 2023, many people were of the opinion that the venture capital community had hit rock bottom and would slowly but steadily begin to emerge once again as an attractive investment option for LPs. The first 10 days of March shook the foundations of this belief with the collapse of Silicon Valley Bank—not only venture capital’s most important bank but arguably the single most important service provider in the entire VC ecosystem. Like the spelunking community in 2017, the VC industry reached a new depth.
Steadying the tide?
There are many different ways to measure the health of the VC universe: the number of venture-backed companies reaching a successful exit, the number of unicorns, and the value of venture deals are some of the metrics that we look at closely at Juniper Square.
For our clients, the amount of LP capital raised by VC funds is a leading indicator of investor appetite. At first glance, the above graph suggests that 2023 is off to an awful start in terms of LP sentiment, but if we dig a little deeper, things don’t look quite so bad. The $11.7B raised in Q1 2023 might be significantly down from the $73.8B raised in Q1 2022, but it matches the $11.7B raised in Q4 2022. Looking at the data optimistically, the argument can be made that we are potentially at, or at least close to, the bottom of the dip.
Additionally, only 99 VC funds successfully closed in Q1 2023, less than half of the 199 funds closed in Q1 2022, but the average fund size was $118.2M, a 44% increase on Q4 of 2022 and the first increase in average fund size since Q1 2022. It’s uncertain how long the disruption caused by the fall of Silicon Valley Bank will last, but at Juniper Square we expect Q3 and Q4 to see a steady influx of LP capital back into the VC fund space.
Exit value still declining?
One of the key stories of 2022 was the decline in exit value for venture-backed companies. Exit value is an important indicator of the health of the space, as this is where funds generate the bulk of their returns. Looking back over five quarters, the $213B of exit value achieved in Q4 2021 dwarfed the $72.9B achieved across the whole of 2022 (of which Q4 was the worst quarter at only $6.2B). Q1 2023 saw a further modest decline to only $5.8B, but the number of exits achieved is expected to be up from Q4 (pending final numbers). For the second and third quarters of 2023, we expect exit value to remain low but believe we’ll see modest growth as we go into the final quarter of the year—although it will be a long road back to the lofty values seen in 2021.
Gradual decline of deal count & value
At $37B of deal value, Q1 2023 was the worst quarter since Q4 2019. In terms of deal count, Q1’s 2,856 deals were the lowest number since Q4 2017. How long the lack of activity will last will prove to be interesting. Since fund managers sit on record amounts of dry powder, and many venture capital-backed companies need a fresh injection of capital, there is a valuation stand-off. The longer this stand-off continues, the more pressure fund managers will have to deploy capital and the more pressure venture capital-backed companies will face to take capital at lower valuations to prevent running out of operating cash.
Anecdotally, among our clients and partners, we are hearing early signs that the valuation disconnect is resolving—companies are either taking capital or seeking exits, and venture capital deal activity may remain flat or even begin to increase again as we progress further into the year.
The worst was feared when Silicon Valley Bank closed its doors in early March, but swift intervention by the FDIC meant that worst-case scenarios appear to have been avoided. Although the ripple effects will undoubtedly continue into Q2 and beyond, recent data seems to suggest that the VC industry has reached or is approaching rock bottom in many key metrics.
At Juniper Square, we remain optimistic and are watching macroeconomic signs like interest rates, inflation, and GDP to see how quickly the VC industry might settle into a new normal.