Uncertainty and Lack of Exits Continue to Impact VC Market

A Quarterly Wink and a Glance at Venture Capital 

There is little doubt that the venture capital (“VC”) market has been negatively impacted over the last several years by the pandemic, geopolitical instability, and the uncertain future of interest rates. Q2 2024 performance may have finally shown that the VC market has bottomed out and is on the road to recovery. In Q2 2024, $56 billion was invested in more than 4,200 deals, which represented the highest quarter in terms of dollars invested since Q2 2022. For the first six months of 2024, $93 million was invested in more than 8,200 companies. At this pace, VC investment for all of 2024 should exceed the $166 million invested in 2023. 

Flight to Quality Companies at Pre-Seed and Seed Stages 

Q2 saw $3.3 billion dollars invested in pre-seed and seed-stage companies, which was similar to the level of dollars invested prior to the COVID years. Approximately 1,500 pre-seed and seed-stage deals were completed in Q2, and it was the best quarter in terms of the number of deals since Q1 2022. In addition, the average deal size, even at the pre-seed and seed stages, has been going up. This shift to larger deal sizes is certainly a reflection of higher valuations and VCs being more cautious and limiting their investments to only the best companies—those exhibiting product-market fit and revenue traction. 

Pre-Money Valuations Up Across Every VC Stage 

It should come as no surprise that as VCs are investing in higher quality and more advanced companies (and maybe doing fewer deals) that valuations would be on the rise. Valuations for VC deals for the first six months of 2024 are up across every stage when compared to 2023. Pre-money valuations for the first six months of 2024 for pre-seed, seed, early-stage, late-stage, and venture growth were $6 million, $12.4 million, $45 million, $68.6 million, and $238 million, respectively. The pre-money valuation increases when compared to 2023 for pre-seed, seed, early-stage, late-stage, and venture growth were 2%, 8%, 29%, 42%, and 70%, respectively. These year-over-year valuation increases are evidence that good companies can raise capital even in challenging economic and geopolitical times. 

Exits an Issue for Investors and Founders 

Exits for VC-backed companies usually come through IPOs or M&A transactions. Exit activity is the driver for returning capital to LPs and influencing the reinvestment of capital back into the funds. For the first two quarters of 2024, approximately $19 billion of exit value was generated via M&As of VC-backed companies, and this is only marginally better than the similar period in 2023. When comparing the first six months of 2024 with the same period in prior years, 2024 would be the second lowest year for M&A activity in the last 10 years. 

The IPO market for VC-backed companies has remained dismal. Only 14 VC-backed companies went public during Q2, and through the first two quarters of 2024 only 37 VC-backed companies have gone public. So far this year, the pace of IPO activity is less than that seen in 2023 and 2022. Clearly, the exit market for VC-backed companies continues to struggle; consequently, funds are experiencing a liquidity drought.  

Fundraising 

The inability to return capital to LPs has negatively impacted fundraising. So far this year, 255 funds have raised only about $37 billion. This year is on track to be the lowest year for fundraising since 2019. With interest rates still being relatively high, LPs now have alternative places to invest their capital where the level of risk is much less than VC. Even though fundraising has slowed down the past 18 to 24 months, funds are still sitting with a lot of dry powder. Almost $300 billion of dry powder is presently available, and about 67% of this dry powder is in funds of 2020 through 2022 vintage. More than half of this dry powder is in funds greater than $500 million and will probably be focused on late-stage or growth funds. 

Investment in Digital Health Rising 

VC investments in digital health peaked in 2021, with about $29 billion invested. Digital health investments declined in 2022 and 2023 but look to rebound in 2024. VCs invested almost $6 billion in digital health companies in the first six months of 2024, and this sector is certainly on track to top the $8.2 billion invested in 2023. Investment in digital health is rebounding as artificial intelligence (“AI”) brings investors into the industry. In fact, one third of the VC dollars invested in digital health went to companies aggressively using AI. Many VCs see the opportunity to utilize AI to make providing healthcare more efficient and effective and to decrease the time needed for drug discovery. Even with a quiet IPO market, a pair of digital health companies has completed successful IPOs during the first half of 2024. 

Outlook 

Even though returning capital to LPs is still a challenge, there are reasons to be optimistic about the current and future state of the VC market. Maybe we hit the bottom of the VC market in 2023, and now the VC market is again on the rise. Time will tell. In Q2, deal count hit the highest level since Q2 2022, and Q2 deal value was the highest over the past eight quarters. The excitement around AI will increase dollars invested in AI-enabled companies across all verticals. With so many AI companies being formed, investors have the responsibility to determine which companies have a true competitive advantage. Let’s see if VC dollars invested continue to increase in the second half of 2024 and if IPO activity and M&A activity with VC-backed companies show signs of a recovery through the summer.