The first quarter of 2023 was bleak for the venture capital and startup sectors, as late-stage deal value declined for the seventh straight quarter to just $11.6 billion and exits collapsed altogether, according to the latest report by the National Venture Capital Association and Pitchbook.

Silicon Valley Bank’s collapse was a major, unexpected event that dominated the narrative in March, and the impact of the bank’s failure sent shockwaves as it was at the center of the innovation ecosystem, as it usually supplied bridge loans for startups raising money.

While the impact of the bank’s failure will likely not be immediately visible in the data, and the potential devastation from the event seems to have been largely avoided, it was another unneeded pressure on the market, said Vincent Harrison, an analyst at Pitchbook, in an interview with VentureBeat.

“The first quarter of the year met expectations in terms of following the downward trajectory that we saw in Q4,” Harrison said. “In Q4 2022, we started to see things go down. The expectation for the most part was that things would continue to go down and that pretty much held up. Whether it is fundraising or deal activity or exit activity, everything continued the trend downward.”

He added, “I think everything that happened this quarter meant things were going to be down regardless of what happened with SVB. But again, SVB just exasperated the problems. It just scared a lot of people. The market is very reactive.”

But SVB assisted with capital calls as well, and now that money has likely disappeared from the system as well, Harrison said.

VC investments have fallen consistently over the past year as the market further condenses from the expansion of 2021, according to the Q1 2023 PitchBook-NVCA Venture Monitor.

Late-stage deal value fell to $11.6 billion as investors shied away from larger deals to preserve capital at a time when cash is short. Just 19 late-stage mega-rounds occurred in the first quarter of 2023, compared with 98 in Q1 2022.

Not only has this widened the funding gap between startups seeking capital and investors willing to provide it, but it has also put downward pressure on deal pricing. In Q1 2023, the median late-stage VC pre-money valuation fell 16.9% from the 2022 full-year figure to $54.0 million, while the average pre-money valuation declined by more than $100 million to $159.1 million, Pitchbook said.

Just $5.8 billion in exit value was closed in Q1. That is less than 1% of the total exit value generated in the record year of 2021. With IPOs unattainable (only 20 public listings occurred in Q1), pressure continues to build within the ecosystem due to the high number of unicorns unable to realize returns for investors, the report said.

“We’re still not out of this. This exit desert is still down,” Harrison said.

The market has been left with inflated valuations built on high multiples from the past couple of years. That means that such companies cannot raise further funding unless they accept “down rounds,” which most investors and startups avoid.

Even though the exit count estimate increased slightly quarter to quarter because of relatively strong acquisitions, such deals cannot provide the amount of capital needed due to these high valuations.

By the end of the first quarter of 2023, the fundraising momentum of 2021 had all but dried up, with a meager $11.7 billion closed across 99 funds. Capital commitments continued to concentrate in larger-size vehicles, but just two funds closed on $1 billion or more (36 were closed in 2022). The sluggish pace of fundraising for emerging and first-time fund managers could be a precursor to formidable fundraising experiences through the end of the year.

The problems are many. Continued instability abroad, stubborn inflation rates, and several high-profile bank failures contrasted with a bevy of positive macroeconomic indicators spread a plume of anxiety across the markets.

Finance—especially VC—is fundamentally prospective, and when the invisible hand that writes the rules of the market is revising them without warning, investors tend to reduce their activity until they have some visibility. But Pitchbook/NVCA said it would be a mistake to refer to the climate as entirely pessimistic: GDP and employment figures, as well as major stock indexes, were all relatively robust at the end of Q1.

However, the market’s lack of confidence is obvious, and while symptoms of a healthy VC market are clear, the mechanisms of action required to restore it are not as well understood, the report said.

VC activity dropped in all stages and sectors in the first quarter of 2023. But beyond noting the continued trend, the utility in referencing the raw numbers is questionable. There are opportunities for more relevant insights when comparing the relative performance of categories against each other, the report said.

Stage activity was notable for the steep decline in the proportion of angel and seed rounds relative to other rounds of investment.

Angel and seed activity declined to 34.0% of all deals made in Q1; although it usually hovers around 47% and dipped to a low, but not unprecedented, 38.4% in Q4 2022, angel and seed investment currently makes up its smallest share of venture investment in at least a decade.

Software deals dropped 22.9% relative to other sectors—but when compared with long-term averages, most sectors were flat or modestly down relative to each other.

Notably, commercial products and services increased its share of deals by 2.0% compared with the 10-year average. The venture community’s response to the changing market has not been uniform across investor classes. Buoyed by mega-deals such as the late-round financing of Stripe in Q1 2023, crossover and nontraditional investors maintained or increased their share in the market.

While their total level of capital invested has been down over the past several quarters, the slope of that decline has flattened relative to traditional VC. Even the modest pullback of nontraditional VC investors has emphasized their importance in the ecosystem, especially for growth investments, the report said.

Abysmal fundraising

Among traditional investors, 2023’s fundraising has been abysmal, the report said. Just $11.7 billion was raised in Q1. This quarterly and year-on-year decline is steep enough that it is hard to contextualize. Whether the trend will continue, or soon reverse, remains unknown. In comparison, consolidation of capital into larger firms is a more certain trend in the industry.

In Q1, 62.8% of all funds raised went to funds that were $500 million or more, with experienced managers holding the largest share of capital for at least a decade. The impact of this trend on VC remains to be seen, but there will be questions about the dynamism of the market and its accessibility to a more diverse talent pool if legacy players continue to expand their share of the market.

While 2022 was a decent year for M&A activity, it was VC’s lowest year for public listings since 2016. The closure of the IPO window in 2022 has continued into 2023, with most of the VC-backed public listing value in 2023 coming from a handful of mega-deals, the report said.

This trend has continued in M&A, where disclosed transaction values were the highest in at least a decade. This has driven investors to exit later and later, with portfolio company ages and the proportion of insider-led follow-on rounds nearing all-time highs. While the IPO window remains closed, liquidity needs are starting to drive increased secondary market activity and fund maturations are expected to push M&A later in the year, the report said.

A lousy short term

Venture funding isn’t a short-term business. Investors need to be confident to invest entire portfolios in assets that are mostly illiquid for years, the report said. Countless factors, including the COVID-19 pandemic, the Russian invasion of Ukraine, and deglobalization have upended decades of received wisdom and thrown a mature business cycle into chaos.

Additionally, high interest rates, the failures of Silicon Valley and Signature Banks, the possibility of government default, increased venture debt, and “unprecedentedly onerous” new regulations being proposed by the Securities and Exchange Commission are all potential pitfalls for the industry, the report said.

However, opportunities also exist. More realistic valuations, combined with a market awash in talent and new government programs designed to assist company formation in high-growth strategic industries, are all positive signs, the report said.

Confidence is a scarce commodity right now, and the net present value of prudence is undeniable. 2023 has already made headlines and shows no signs of slowing down. However, if investors can meet the changing market with the right mix of diligence, patience, and optimism, then venture capital’s best days are yet to come.

Stripe’s latest financing round drove a large portion of the deal value with nontraditional investor participation. With the exception of CVC investors, nontraditional investors are pulling back in response to a lack of viable paths to liquidity and public market volatility, the report said.

With the ongoing rate hikes and falling valuations, late- and venture-growth-stage startups faced significant challenges while looking for an exit path in Q1. Trapped in a capital crunch caused by the withdrawal of nontraditional investors and a hostile exit environment for companies planning on going public, mature startups were also subject to increased pressure from the existing investor syndicate to achieve liquidity, the report said.

The push toward a near-term exit will likely lead to an uptick in acquisition activities from corporations with ample cash reserves. B

Despite its relative resiliency throughout 2022, deal activity in the angel and seed stages trended downward substantially through the first quarter of the year. Q1 deal value fell to $3.3 billion, a 53.1% decrease from Q1 2022, across an estimated 1,396 deals, demonstrating that even the most nascent stages of VC are not immune from the widespread effects of an economic downturn.

While angel-and seed-stage startups are generally thought to be mostly insulated from market volatility, they are often the riskiest investments because of their relative immaturity compared with more established startups.

This partially explains why the median and average deal sizes for the seed stage increased by 15.4% to $3.0 million and 8.0% to $4.7 million, respectively, while these figures for all other stages of venture declined in Q1. It appears that investors that are still willing to take bets on the earliest-stage startups are primarily taking the risk on the cream Q1 angel and seed activity slumps to 10-quarter low US angel and seed deal activity by quarter.

“Median deal sizes are down across the board with the exception of seeds,” he said.

One of the consequences is that companies are likely to opt for business models that burn less cash, Harrison said.

“Perhaps when they do need to come back to the market or raise capital, you know, they won’t need to raise as much capital,” Harrison said.

In Q1, the median seed pre-money valuation was $13.0 million—a 23.8% increase from the 2022 full-year figure and the highest figure on record. Additionally, the majority of angel and seed deal value has been concentrated within larger rounds, a trend that has been increasing over the past several quarters.

For example, in Q1 2021, 53.8% of angel and seed deal value was deployed to rounds of $5 million or more; in Q1 2022, the percentage rose to 67.0%. Our data shows that 68.2%— or $2.2 billion—of angel and seed deal value was deployed to rounds of this size in Q1 2023, the report said.

As expected, the data shows that deal activity for early-stage venture, despite the stage’s presumed insulating nascency, declined significantly throughout the first quarter of the year. Q1 saw just $9.6 billion in deal value across an estimated 1,197 deals, a six-quarter consecutive decline in deal value and the lowest deal value we have observed since Q2 2020. It is clear that the venture market is no longer riding on the coattails of 2021, a harsh reality for both startups and investors in the current environment, the report said.

One of the most striking observations thus far has been the decline in early-stage deal sizes, with the median deal size in Q1 falling to $6.2 million, a 29.1% descent from 2022’s full-year median of $8.8 million. This notable drop reflects a harsher dealmaking environment with tempered growth expectations and far fewer outsize valuations relative to the past two years. Additionally, ongoing economic volatility and a pronounced lack of exits has heightened the importance of liquidity not only forstartups but also for venture funds and their LPs, leading many investors to slow their deployment of capital into larger rounds as a means of capital preservation.