Torrid bull market eases pace from 2021

While the Venture Capital market slowed in Q1 2022, the $77 billion raised still ranked as the 4th highest quarter ever. 

• After a record-breaking year, VC activity dropped off 13% in Q1 2022, which still ranked as the fourth largest venture investment quarter in history.
• The top three sectors were IT, health care and business and financial services.
• Looking ahead, VC-backed companies are expected to raise somewhere between $250 billion and $275 billion this year.

Venture capitalists invested a staggering $316 billion in 2021. Given this unprecedented showing, we expected a drop-off in Q1 2022, and that’s what we got: VC activity decreased more than 13% in Q1 2022, the largest quarter-over-quarter decline since before the COVID-19 pandemic. Even so, the $77 billion raised last quarter still ranks as the fourth largest venture investment quarter in history.

Even though overall investment was down, several trends emerged last quarter that indicate we may see growth ahead in certain areas. For one, venture-backed companies raised a record $9.5 billion through growth equity financings. And while A and B rounds were off slightly, seed capital experienced the best quarter ever. In addition, on top of a record $74 billion of new venture fund formation in the first quarter, there is a record $230 billion of dry powder on the sidelines. Bottom line: there is more than enough capital to support venture-backed startups.

Mega-round financing

Mega-round financing dropped 24% as a percentage of total capital invested quarter over quarter. This was following a record Q4 2021 that was the most prolific quarter ever. In spite of the dip, business and financial services saw an increase in mega-round financing and topped information technology for the first time since before the pandemic. We saw a significant drop in IT, consumer services and health care.

Sectors

Once again, the usual suspects led the way in overall venture capital investment– information technology, business and financial services, and health care. While most sectors were off, business and financial services was up 6%, to reach $21 billion for Q1 2022, the second consecutive quarter this sector has ranked second. Consumer goods was the only other sector to see an increase last quarter.

While IT was off 17% at $25 billion, it still generated the second largest quarter in history, more than doubling what was raised in Q3 2020. This continues the tremendous growth this sector has experienced over the past year and a half.

On the other hand, consumer services dropped off 45%. While it’s still too early to tell, this could be due to the lingering impact of the pandemic, during which many consumer services startups sought capital to reach consumers. Inflation may also be playing a role as consumers begin to pull back after the spending spree of the last two years.

Health care services also saw a significant drop-off, declining 14% from Q4 21. Health care services saw major growth from companies pursuing financing as they sought to provide telehealth and other virtual services in response to COVID-19, so this might be a natural trend as businesses adjust.

Subsectors

The top three subsectors were software, financial institutions and services, and biopharmaceuticals. While still the largest subsector, software was off 12%, once again following on the heels of a blow-out quarter. Financial services was up 15%, and biopharmaceuticals was up 3%. Startups that focused on renewable energy also emerged with a strong quarter, showing more activity as the deal count rose 24%.

Regions

Silicon Valley and New York accounted for more than half of all VC activity. For the first time in recent memory, Los Angeles joined Boston in a virtual tie for third, with Boston slipping mainly due to the fall-off in health care services. Chicago also experienced a significant spike in activity last quarter, moving into fourth place.

Silicon Valley accounted for 37% of all venture capital activity. Once again software led the way, accounting for over 80% of all IT activity. Financial services was down quarter over quarter, which bucked the national trend. The biopharmaceuticals sector was up 210% in the Bay Area, thanks in large part to a higher volume of deals.

FinTech continues to drive VC activity in New York, which surpassed the $10 billion mark for the fifth consecutive quarter, establishing a new plateau from an investment perspective. Business and financial services had a particularly strong quarter, with investors looking to pour money into startups exploring blockchain, cryptocurrencies, direct-to-consumer payments, and other financial infrastructure.

The decline in health care contributed to lower activity in Boston, which was off 33% quarter on quarter and 42% year over year. This was not surprising given that it followed on the heels of a record quarter in Q4 2021 and a strong showing for 2021.

On the other hand, Los Angeles emerged to almost eclipse Boston as the third highest VC region. As a region, Los Angeles was off only 2% from Q4 2021, with consumer services raising almost $2 billion out of the $5 billion raised last quarter. In fact, half of the top 10 deals last quarter were consumer services or consumer goods deals.

Chicago also saw significant VC activity last quarter, reaching the $2 billion mark for the first time and moving into fifth place. This was largely driven by business and financial services, which accounted for 67% of the overall activity in Chicago.

Overall outlook

As mentioned earlier, a down quarter is not a surprise. The VC market has been on a tremendous bull run for the past four years, and it’s doubtful that 2022 would have surpassed 2021, even without the head winds of inflation and geopolitical uncertainty.

We continue to be in a unique time as the market comes off the heels of a remarkable amount of venture activity. This has created a robust market for entrepreneurship and technology solutions across a broad spectrum of companies. This was also a record fundraising quarter for capital formation and for the first time, this has produced a record amount of available capital to invest, with venture fund formation nearly equal to investments in startups. In addition, private equity has emerged as an asset class that has continued to show robust support for the venture-backed startup market.

On the flip side, we are now seeing real inflation for the first time in decades, which is something that most investors and operators are unaccustomed to.  This has significantly impacted the technology public markets, which influences what portfolio companies look to for their future payoffs and, perhaps even more importantly, their current valuations. The losses in these markets in the first quarter will undoubtedly weigh upon the venture market. At the same time, the real and looming geopolitical instability will continue to impact the global economy in real and unseen ways.

In response, companies are naturally taking a more defensive posture, establishing, expanding or tapping debt positions to protect their access to capital. They are also raising equity as they can and focusing on getting to break even and plotting a path to profitability as the skies get cloudy.

Looking ahead, I expect VC-backed companies to raise somewhere between $250 billion and $275 billion this year. While this is still a strong performance, the days of irrational exuberance are over. Like all markets, this one has cycles. For a unique set of reasons, the venture market has seen incredible growth over the past 10 years.  It’s too early to tell how challenging things will become, but I expect this is a time when great entrepreneurs will separate themselves from the rest of their peers.