It was a mixed year in 2022 for venture capital as fundraising hit an all-time high, whereas deal activity slowed and exits capitulated. The start of this year should see these trends move in the same direction as appetite for fast-growing startups wanes and investor focus shifts to profitability and margins in the face of potential economic challenges ahead.
Fundraising sets a record, again
New capital flowed into venture capital funds at record levels in 2022. Much of this occurred in the first half of the year as momentum from 2021 motivated venture capital managers to continue delivering the home-run exits that characterized a blistering VC market in 2021.
U.S. venture capital fundraising activity totaled $162.6 billion in 2022, up 5.5% from $154.1 billion in 2021, PitchBook data shows. This was a remarkable feat, considering that 2022 was a down year for venture capital by all other measures, and that 2021 saw a jump of 65% over the 2020 total of $93.3 billion. 2022 carried on the trend of venture capital fundraising activity achieving successive record totals since 2018.
Hidden in this record total, though, is the notable slowdown in fundraising toward the end of 2022. Approximately 75% of the $162.6 billion raised in 2022 came in the first half; but the second half ended with a whimper—the final quarter contributed less than 10% of the full year total.
Also notable is a significant concentration in fundraising to larger and more established venture capital managers. While the total for the year increased in dollar terms, the number of funds that received this capital dropped 39% to only 769 in 2022 compared to 1,270 in 2021.
Deal activity slows, but remains resilient
Deal activity for 2022 totaled $238.3 billion, down 31% from the previous year’s record of $344.7 billion, according to data from PitchBook.
2021 was a phenomenally good year for venture capital activity that was tough to beat. The $344.7 billion colossal record set in 2021 had shattered the previous record of $171.2 billion set in 2020 by a whopping 101%. Setting 2021 aside as an outlier year, venture capital deal activity held up remarkably well, given that 2022 represented a jump of 39% over 2020 and sits well above pre-COVID-19 levels.
However, similar to fundraising activity, momentum slowed over each successive quarter in 2022. Close to two-thirds of the total came from the first half of the year while the fourth quarter recorded $36.2 billion in deal activity, the weakest level since the fourth quarter of 2019 and a dismal comparison to the heady total of $93.9 billion in the final quarter of 2021.
Deal count fared better. PitchBook estimates that 2022 closed with a total deal count of 17,990, down only 3% from last year’s record of 18,521. This means average deal sizes dropped to $13.24 million from $18.61 million in 2021, as venture capital managers favored cutting smaller checks to fund early-stage deals as opposed to the larger outlays required for late-stage companies.
Exits fall off a cliff
Exits were the dire story in 2022. U.S. venture capital exit activity in 2022 amounted to $71.4 billion, a pittance compared to the staggering total of $753.2 billion from 2021 and representing a 91% decline.
One has to go all the way back to 2016—a seemingly different era in the fast-evolving venture capital world—for a year in which venture capital exits were at the levels seen in 2022.
This massive drop-off is largely attributable to the frozen market for initial public offerings, the most lucrative exit route for venture capital. Only 76 IPO exits of venture-backed companies occurred in 2022 compared to 303 in 2021; with a total exit value of $34.4 billion in 2022 versus $637.9 billion in 2021. This 95% decline was due to a much weakened and volatile public equity market that saw the S&P 500 drop 19.4% in 2022 and record its worst year since 2008.
Exits via acquisitions and buyout transactions were not as catastrophic, dropping 31% and 28%, respectively, but these do not drive the aggregate exit totals as much as IPO activity, which fell off a cliff.
Momentum based on the fourth quarter of 2022 showed a slowdown in all metrics, and we expect this to spill over into the first half of this year. Sentiment should remain measured as venture capital investors evaluate economic headwinds and take a cautious approach to see how conditions evolve.
The Federal Reserve’s interest rate policy and ongoing battle with inflation will be at the top of investors’ minds as they look to see if inflation can be tamed without tipping the economy into recession. As long as recession fears loom, the focus will be on earnings and profitability, which does not bode well for venture-backed companies that tend to focus on topline revenue growth at the expense of earnings.
The Fed’s current position of continuing to raise interest rates and maintain them at restrictive levels throughout this year will also make investment in growth companies less attractive and should keep deal activity constrained. Deal activity will not dry up as venture capital has a healthy war chest on the back of several years of record fundraising totals.
We expect the increased activity in early-stage companies to persist given the more speculative and revolutionary nature of these investments, which allow them to play by a different set of rules and afford them the latitude to be less sensitive to current conditions.
Large established managers should continue to garner most of the fundraising action, albeit at a much more moderated pace relative to last year. Venture capital funds did not return enough capital in 2022 to allow investors to recycle capital back into fresh commitments of new venture fund launches, particularly those sponsored by small or emerging managers.
Exits will follow the story in the stock market, which drives the health of the IPO market. The year is off to a good start with the S&P 500 Index up and financial conditions showing signs of a fledgling recovery. However, it is early in the year, and the Fed may hold sway should financial conditions get too rosy as to interfere with their goal of bucking inflationary pressures.