enture capital investors will not soon forget 2022. The year was dominated by choppy public markets that spilled over into the private markets and no shortage of big headlines. After a massive year for tech and VC in 2021, investors were a little bit anxious coming into the year but probably did not expect things to play out like they did. The Federal Reserve took the reins and did not let go and crypto and tech valuations fell off a cliff. Let’s look at the five biggest VC stories of 2022 and their impact on the sector.
5. The Fed came to play
In 2021, members of the Federal Reserve stuck firmly to the idea that inflation would be “transitory” due to pent-up demand from the pandemic. But after inflation hit the highest level seen in more than 40 years, the Fed realized it was behind the curve and proceeded to move fast to get inflation under control.
The Fed’s benchmark interest rate began 2022 at practically zero and exited the year inside a range of 4.25% and 4.5%, which included four jumbo-sized 0.75 percentage point rate hikes. The rate hikes ripped through the market, sending the Nasdaq Composite down roughly 34%. Rate hikes make high-growth stocks less appealing because they reduce the future value of cash flows and make safer assets yield more.
As if the rate hikes weren’t enough, the Fed also sharply reversed course from its easy-money policies that have seen it pump trillions of dollars into the economy since the Great Recession. The Fed stopped buying bonds, which funnels liquidity into the economy and is now allowing about $95 billion of bonds to mature and run off its balance sheet each month. This is now draining liquidity out of the economy, which could over time reduce the flow of funds into VCs and startups.
4. Exits heading for a five-year low
Market turbulence and lower valuations made going public much less attractive. As such, U.S. initial public offering activity all but came to a halt causing large, highly-anticipated late-stage companies like Chime and Instacart to postpone their IPOs.
Going public is a key way that startups exit so with the market frozen, exit activity and value fell significantly. You’ll also notice that the market for financial vehicles such as special purpose acquisition companies also came to a halt. In fact, total exit activity looks to be headed toward a five-year low in 2022. Roughly half of all U.S exit activity through the third quarter of the year came from acquisitions.
This will be an ongoing issue for late-stage startups that need liquidity. It could force them to go raise more capital to extend their runway. Interest rate hikes are expected to slow soon but the economic outlook for next year could include a recession. IPOs are expected to rebound next year but slowly, so this will be an issue to watch.
3. It’s all relative for VC/startup funding
There’s no doubt that market conditions have finally caught up with U.S. startup funding and really started to weigh on deal activity. In Q3, there were 4,073 deals, which is down about 20% from the record high nearly 5,050 deals posted in the first quarter of this year. The $43 billion of total dollars that flowed into startups of all stages in Q3 represents a nine-quarter low.
Still, through the first three quarters of the year, U.S. VC deal activity had already surpassed every year but 2021. It’s really a tale of two halves as startups were able to ride the booming momentum from 2021 before facing an abrupt slowdown.
Meanwhile, VCs have also managed to keep fundraising. After having already raised a ton of dry powder in 2021 VCs continued to build dry powder. In 2021, nearly 1,140 funds raised a record $147 billion. This year through the first nine months, U.S. VC funds had already raised close to $151 billion, likely due to all of the momentum heading into the year. While the incredible levels of fundraising are starting to slow they are still quite healthy, all things relative. There were also a record amount of funds raised this year with at least $1 billion.
2. Optimism for 2023
The private and public markets have been on a roller coaster ride since the pandemic begun, experiencing the highest of highs in 2021 to a sharp reversal for most of this year. Starting in 2023, the environment is still murky with the direction of the Fed and the economic outlook unknown.
But after the hardships of this year there are already calls that the VC outlook will improve as markets and valuations stabilize and IPO activity hopefully starts to rebound.
"Fear not—year-end 2023 headlines will look a lot better than today's. The current news cycle may be rough, but persistence and innovation combined with an improving economic outlook will restore the optimism that has always defined our industry," said Gene Frantz, a general partner at Alphabet’s independent growth fund Capital G.
1. The FTX debacle
It’s no secret that top VC funds like Sequoia and Andresson Horowitz have been investing heavily in the crypto space, especially as it took off in 2021 with the price of Bitcoin topping $68,000. But when the large crypto exchange FTX filed for bankruptcy in November, it really cast a dark shadow over the entire sector.
FTX Founder and CEO Sam Bankman-Fried is being charged for wire fraud, money laundering, and campaign finance violations. Bankman-Fried and other executives allegedly used customer funds to prop up its sister trading firm Alameda Research after the firm made several bad investments. The list of VC firms that invested in FTX includes big names like Tiger Global, Sequoia Capital, Lightspeed Venture Partners, Ribbit Capital, and many more. Sequoia partners even supposedly apologized to its limited partners and said that they think they were misled by Bankman-Fried.
Investors ranging from retail to venture capital are now very skeptical of crypto, which had already been in a brutal crypto winter before the FTX collapse. Expect crypto investment to likely slow in the near term and for investors to approach the sector very cautiously.
So there you have it, the five biggest stories in VC of 2022. Some people are calling it the year the party ended. Others are calling it the hangover, or even the new normal. What we can all agree on is that 2022 was a year of reckoning for venture capital.
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