Fundraising in Confusing Times

We spend a lot of time raising money, both for companies and investment vehicles. And so we have some thoughts about the current state of the fundraising market, but forewarning – we really have more questions than answers. There is a lot of uncertainty in the markets right now.

First, from a company fundraising point of view, conditions are not great. The latest Pitchbook/NVCA data shows deal activity is down considerably from this time last year. The amounts raised in the first two quarters are less than half of the same period last year.

Source: Pitchbook

However, they estimate the number of deals has fallen, by a far lower amount. There are a few ways to interpret that. Critically, it means that deal values are down significantly. Given that most people agree that valuations had gotten out of hand in 2021/2022, this is not surprising. But it still hurts. We think VCs are are trimming their portfolios, either explicitly or implicitly, foregoing follow-on rounds in much of their portfolio to focus on those companies they think are doing best. This does not seem as painful as in prior downturns because many companies saw this downturn coming far enough in advance to stock up their cash balances. In addition, the overall economy is still fairly healthy. This seems to mean that most portfolio companies fall into the “Save” bucket, it’s just that they are burning far less and thus not raising as much.

Anecdotally, we have seen a big shift in our consulting practices. On average, over the past decade about half of our consulting work came from early-stage companies. Today, most of that has dried up. Companies that raised money earlier this year had to fight tooth and claw through a very protracted process, but they were able to raise money in the end. However, start-ups still on the roster are starting to do betterl – hitting their targets, building revenue, and are starting to dip their toes in the funding markets a bit more readily. On the other hand, the corporate side of our business has picked up sharply. Right now, we are not doing much targeting work for big companies looking to make acquisition, but our sense is that is not too far over the horizon.

All of this is to say that start-ups have cut a lot of costs and hunkered down. Assuming the US does not enter the recession that Wall Street is convinced is coming any day now, we think start-up fundraising should start to pick up later this year or early next year. That market will not be a return to the frothy early 20’s, but should at least allow companies to start hiring a bit more and return to their Quest for Growth.

That being said, the market for new venture funds remains trapped in molasses. One new fund we have been working closely with over the past two years encapsulates this pretty well. A year ago, they were able to go from first LP meeting to getting a check in six to eight weeks. Then the markets imploded in the second half of 2022. Now it takes nine months to go just from the first meeting to second meeting. LPs love the. thesis and love the team, it’s just that they cannot make investment decisions.

Our sense is that these LPs do not have much clarity of the value of their allocations. In 2022, they may have allocated 5% of funds to venture. Now they know that many of the VCs holding their funds have seen paper values of their portfolio fall considerably, but those VCs are reluctant to take full write downs on those portfolios. Beyond contractual obligations, many VCs are reluctant tor recognize the full extent of the write-downs because that makes raising their next funds that much harder. So LPs may see that on paper they have 6% or 7% venture allocations, and so they need to reduce their exposure. At the same time, they recognize that in reality they probably have only 3% or 4% in venture. Any rational person would just wait this out. And to be clear, there are plenty of venture funds that are doing well, but beyond “AI” it is hard for anyone in this ecosystem to feel much cheer.

The whole industry is still very much in the process of adjusting to a very different interest rate environment. Everyone is still trying to figure it all out. Hopefully, things will start to clear up soon, but our sense is that we still have a ways to go and a few more shoes to drop before things start to resemble a new normal.

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