The venture capital landscape continues to test the discipline and diligence of investors and startups alike. Like many other asset classes, venture capital continues to be impacted by lingering macroeconomic factors affecting funding and liquidity prospects.
Factors that continue to constrain funding activity—and largely affect the entire industry—include slow-to-decline interest rates, lingering inflation, caution and heightened scrutiny from investors, low IPO activity, and residual side effects incurred by startups, namely layoffs and decreased valuations.
While there has been notable deal activity for the first quarter of 2024 (and even some megadeals), VC investments remain at a five-year low. With IPO activity also at its lowest level since 2016, there is a backlog of startups waiting for late-stage funding and investors waiting for liquidity events, further crowding the VC fundraising scene.
Below, we explore the factors constraining venture capital funding into the first half of the year, and the ways investors can leverage crucial market intelligence to gain a competitive advantage in the shifting landscape.
The VC Funding Dryspell
Venture capital investment fell to the lowest activity in nearly five years for Q1 2024. Investors funded $76 billion in the period, their lowest since the second quarter of 2019. The number of deals also plummeted to a four-year low.
While VC deals on the whole are down and hovering near historic lows, there is still notable activity—even some megadeals. The top three trending sectors—information technology, healthcare/biotech, and business and financial services—ushered in funding rounds over $100 million since the beginning of the year.
On the whole, high interest rates and underlying macroeconomic factors continue to act as headwinds for funding and deal activity in the VC space. As a result, investors remain overly cautious about deploying funds, despite record-high ‘dry powder’ reserves exceeding $300 billion at the end of Q1.
An expert perspective sourced from the AlphaSense platforms captures the conundrum VC investors face in a high interest rate environment:
“Right now, in this current environment, money is tight. Interest rates are high. If they have to go to the bank, they may be paying more on a note than they were a year ago if interest rates are higher. It may be that the venture capital organizations that are supporting those may find better investment opportunities given the fact that investing in start-ups and small companies and companies trying to get their products to market may not necessarily be a financially feasible venture given the high failure rate.”
– Director, Pharmaceutical Company | Expert Transcript
Heightened Competition for Funding
According to a quarterly report published by the National Venture Capital Association (NVCA), there is a disproportionate number of startups seeking capital relative to available funding, as predictions of a widespread ‘mass extinction’ among startups lingers. The NVCA estimates that around 55,000 venture capital backed startups in the US are competing for funding in the dried up environment.
There is heightened demand for funding at each stage, as illustrated below. Late-stage and venture-growth startups are seeking twice as much capital as investors are willing to deploy.
According to an outlook published by Wellington Management, distributions from VC funds dropped a staggering 84% from 2021 to 2023, further growing dry powder inventory and extending the allocation drought. Competition for fundraising will continue to be a prevailing trend among startups in 2024.
Findings show that VC investors are no longer buying into the idea that good valuations alone drive good investments, and gone are the days of young founders racing to raise $100 million of capital with scarcely-formed business models, no products or customers at launch, and short-term exit strategies.
Instead, experts agree that investors will likely turn to innovative start-up companies with promising growth plans and strong leadership teams. Startups that survive the funding drought and succeed in securing allocations will be those with experienced, executive-level leadership and compelling customer-centric solutions.
These prospects are more likely to secure financing ahead of their more risky, underdeveloped counterparts. Investors are more discerning than ever with their capital, as a result of economic circumstances, but also the intrinsic high failure rate that is common with start-ups.
Exit Backlog and IPO Stagnancy
The start of 2024 saw IPO activity at its lowest level since 2016, as a result of swelling interest rates, geopolitical tensions, and ongoing economic volatility. The fundraising drought has undoubtedly also played a role in the ‘IPO winter,’ as the market awaits a resurgence in activity.
Notable recent IPOs that made long-awaited debuts to public markets include Reddit, Astera Labs, and Kyverna Therapeutics. In its first day of trading, Reddit’s shares soared 48%, nearly two and a half years after filing its original IPO. Astera Labs also debuted last month as the first VC-backed IPO of 2024, closing their first day of trading up 72%.
Exits for US-based VC firms in Q1 were also the lowest since 2016, as the stagnancy trend lingers. The exit backlog includes 731 “unicorn” companies with a total valuation exceeding $2.4 trillion. These companies, with valuations over $1 billion, have been held within VC portfolios on average for more than eight years.
This exceedingly long holding period poses inherent liquidity risk to investors. It may also extrapolate fundraising woes, as weary investors grow reluctant to fund even good opportunities without a clear exit strategy in sight.
The fundraising environment will continue to be challenging across each maturity stage, as the backlog of startups waiting for late-stage funding and investors waiting for liquidity events will continue to crowd the VC scene.
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Financial Research Leader
Barb is a Financial Research Manager covering the financial services segment at AlphaSense. Previously, she managed the content program at a global financial services firm.
Read all posts written by Barbara Tague
