Are we in a downturn? I am no economist, but in the global Silicon Valley, 2022 was all about the early stage in tech.
Strong headwinds in financial markets, compressed multiples leading to substantially lower valuations, accelerating inflation and higher interest rates, war, pandemic and supply disruption, have been only some of the uncertainties that made 2022 such a challenging year. Like other parts of the world, these factors have has impacted every facet of the venture capital and innovation world with diminished valuations and a slowdown in investment. But has it impacted certain funding rounds differently? Crunchbase recently took a deep dive into how the downturn is impacting Series A financing, and the findings are quite interesting.
From all that I could see in my daily life as a corporate lawyer for emerging growth businesses and investors, early stage was the place to be in 2022. According to Crunchbase analysis, 2022 was a good time for companies at Series A stage, with investors favoring startups raising Series A financing as opposed to later stage companies. While Series A funding did decline in 2022 (along with funding across all stages), the decline was not as steep as it was for other stages. Crunchbase data shows Series A funding fell by 23% last year, compared to a 30% drop for Series B and a 45% drop for Series C.
The analysis shows $70 billion in global Series A investment going to approximately 4,000 startups as of December 11, 2022. Again, that is down from the $90 billion invested globally in 5,000 companies in 2021, but there is still an impressive appetite for investment at this stage. It is also important to remember that 2021 was a record-breaking year for investment across the board, so it is not surprising to see that drop off a bit and normalize.
One interesting note in the data is the US market showed a sharper pull back in 2022 compared to other areas, with a 33% decrease in Series A funding. They do point out that Series A dollar amounts in the US grew faster than other areas in 2021, with a 125% increase over the prior year. This could account for the larger drop off in the US market in 2022 as compared to 2021.
So, what does it all mean? First, despite the global economic issues facing startups and investors in all sectors, venture capital and private equity has never had a mountain of dry powder as high as they do today. Earlier stage startups that can demonstrate stability and potential for substantial growth are favored because their perceived risk of under-performance is lower. But the heavier drop off in funding for later stage rounds means that those startups who have secured Series A funding now might have a harder time as they move into their later rounds. This means they should prepare now for the possibility of more difficulty securing funding down the road.
Strategies to extend the runway include trying to extend your last round of financing to raise additional capital, or to use a convertible note or simple agreement for future equity, and concede to a lower capped valuation than your last priced round to convince investors to put in new money. The benefit is that startups do not have to announce a dreaded “down-round” and all of its perceived psychological effects. Other non-dilutive strategies include multi-year revenue deals to accelerate cash collection, government funding or grants of some kind.
Only time will tell what 2023 will bring, but most experts predict this depressed valuation environment will last at least through the first half of the year. Smart founders will continue to operate as efficiently as possible, using their funding in the most strategic ways to weather the new season in venture capital and innovation funding.