The venture capital bull market has run its course, but reports of its demise are premature

Venture capital continues to fall off from the 2021 numbers, but the results still point to the second biggest year on record.

Executive summary

• VC-backed companies in the US raised $58 billion in Q2 2022, a 23% decline from $77 billion in Q1 2022, which still outpaces any quarter from 2020. 
• Venture capitalists still raised $122 billion in new venture funds so far this year, putting 2022 on pace to be the third record-breaking year of fund formation.
• With fundraising expected to be difficult through the rest of the year, entrepreneurs will need to focus on networking and building their businesses.

In spite of dramatic headlines about volatile market conditions, venture capital still recorded a massive quarter in Q2 2022, with investments of $58 billion, a 23% decline from the $77 billion raised in Q1 2022.

All things considered, 2022 will still rank as the second highest investment year in history, even though it will be greatly overshadowed by results of 2021. Macroeconomic factors, including inflation, rising interest rates and geopolitical uncertainties, will continue to serve as strong headwinds throughout 2022 and into the first half of 2023.

Still, it’s not all bad news. Record amounts of dry capital sit on the sidelines to fund further innovation. Venture capitalists have still raised $122 billion in new venture funds so far this year. 2022 is shaping up to be the third record-breaking year of fund formation. Read on for more insights into this quarter’s numbers.

Mega-round financing

In Q2, we saw a significant drop-off in the number of deals and mega-round financing. All told, mega-round financing raised $27 billion in capital, just over half of the total capital raised this quarter.

This is the first time since 2020 that the number of deals has fallen below 200 for a quarter. Given that mega-round volume has dictated the overall dollar volume in the market, this offers a fairly good indicator that dollars raised over the next two or three quarters could be even lower.

Sectors

As in prior quarters, the IT, business and financial services, and health care sectors led the way in Q2 in terms of activity, despite a significant pullback in all three areas. Energy and utilities fell only 5%. Considering the ongoing turmoil in the energy markets, this demonstrates that the right companies can still find opportunities.

While most sectors were off, the bright spot was food and beverage — up by 68% — driven largely by food alternatives, including protein and dairy replacement products.

Another sector that saw a slight rise was business support services, which shows that in spite of volatility, the B2B economy remains stable.

Regions

Continuing its track record of strong showings, the San Francisco Bay Area, led by Silicon Valley, churned out 31% of all capital raised so far in Q2 2022.

While the Bay Area may not crack $100 billion this year (for the first time since 2021), it will definitely beat 2019 and 2020 in terms of dollars invested.

In other regions, New York continued to hold onto second place, but Boston closed the gap with a strong quarter — one of the few regions that experienced an increase over Q1. Denver, San Diego and Seattle all saw a rise in investments, too.

What does this mean for entrepreneurs and investors?

Even as we work through this market downturn, this is not the time for entrepreneurs to lick their wounds. Entrepreneurs should instead continue to network and build their businesses. We suggest they consider the following three points:  

1. Fundraising will not be easy in the months ahead, so before you seek new funding, look for ways to free up working capital to extend the runway of liquid funds.
2. To that end, entrepreneurs should carefully scrutinize any major investment, new building, major hiring spree or general expansion. Without a clear and obvious high return on investment, it’s not worth the risk. This is the time to focus on serving customers and adding value.
3. Conversely, this could be a good time to add talent. As overextended companies trim their head counts, entrepreneurs may want to look for opportunities to recruit high-impact talent as the job market loses some of its tightness.

Finally, companies engaged in fundraising should challenge themselves to be even more efficient in terms of performance. If you’re not getting any traction with investors, refocus on customers and execution. Achieving good results in tough times impresses investors.

From an investor perspective, investors are focusing on what is already in their pipeline, as opposed to new opportunities. We expect many investors to take a pause through the next few quarters and be much more selective. 

Overall, we expect Q3 investments to be lower than Q2. In this current environment, the fear of missing out is gone, and investors can now afford to wait as they review opportunities.

Looking at the rest of the year, we estimate venture-backed companies will raise some $225 billion in 2022. This is not all doom and gloom. There has never been more dry capital to fund innovation. We expect transformational companies to emerge, as we usually see in down cycles. Tough times are often when true leaders surge forward from the pack.

Source:

Crunchbase as of July 8, 2022, Ernst & Young LLP

Disclaimer:

The views expressed by the author are not necessarily those of Ernst & Young LLP or other members of the global EY organization. Numbers included are from EY analysis and based on Crunchbase data unless noted otherwise. 

*We include equity financings into VC-backed companies headquartered in the US. Sources of cash investments include, but are not limited to, VC firms, corporate investors, other private equity firms and individuals.