Venture Capital Slowdown Continues into Q1 2024

A Quarterly Wink and a Glance at Venture Capital – Q1 2024 

The slowdown in VC deal activity, which started in Q3 2022, has continued into Q1 2024. In Q1, $36.6 billion was invested in 3,925 deals, which was at a level comparable to 2023. For all of 2023, $165.8 billion was invested across 15,580 deals. Many factors have contributed to this slowdown including high inflation, uncertainty about future interest rate cuts by the FED, and the somewhat fragile geopolitical situation. 

I recently sat on a panel at a Bay Area venture capital summit, and we were asked to describe the current state of the VC market. The responses that received the most attention were “challenging” and “investor friendly.” Based upon the Q1 data, it is a challenging market for founders to raise capital and for VCs to deploy capital and return capital to their LPs. The last couple of years have also seen the pendulum shift from founder-friendly deals to investor-friendly deals. Investors are dictating much stricter terms in their term sheets. 

Exits Continue to Be a Problem 

There were a couple of notable IPOs (Reddit and Astera Labs) in Q1, but overall exit values were still low. Q1 saw exit values of $18.4 billion, which was slightly better than every quarter in 2023, except for Q3. A total of $11.4 billion of the Q1 exit value was attributed to the IPOs of Reddit and Astera Labs, and only $6 billion was the result of M&As. M&A activity slowed in Q1 of 2024 as compared to 2023. 

The lack of exits has especially hurt the unicorn companies and their investors. At the end of Q1 2024, there were 731 unicorn companies with a total valuation exceeding $2.4 trillion. These unicorns have been held within VC portfolios for an average of more than eight years, which is much longer than the typical portfolio company holding period. This exceedingly long holding period increases liquidity risk for all investors. 

Dealmaking Slow Across VC Lifecycle 

During Q1, only $2.6 billion was invested at the pre-seed/seed stage, and this was down 39% from Q1 2023. Early-stage companies raised $10.2 billion in Q1, which represented a slight increase from Q1 2023. Late-stage deal activity was down 17% in Q1 compared to Q1 2023. 

Clearly, VCs are becoming more cautious and selective when investing capital. They are investing in quality founders and management teams that understand business fundamentals—companies that have shown some level of customer traction and exhibited product-market fit. Founders must also understand how to achieve their next set of milestones while still being capital efficient. 

Valuations Rose in Q1 

Median pre-money valuations for VC-backed companies increased across every stage in Q1 compared to 2023 levels. A good reason for this increase was that only the best companies were able to raise capital in this challenging environment. Pre-seed, seed, early-stage, late-stage and growth-stage valuations increased 32%, 3%, 29%, 40% and 59%, respectively. 

 Slowdown in Fundraising Continues; Significant Dry Powder on the Sidelines 

In Q1, 100 VC funds raised only $9.3 billion. Lack of liquidity and lack of distributions back to LPs have made LPs cautious when it comes to allocating capital back to the VC funds. One of the positive signs for the VC industry is the record amount of dry powder waiting to be invested. As of the end of Q1 2024, VC funds have accumulated $317 billion of dry powder. This record amount of dry powder is the direct result of record fundraising in 2021 and 2022 and the slowdown in capital deployment over the past several quarters. In fact, about 72% of the dry powder is from 2020-22 vintage funds. 

Outlook 

Since it takes “two points to make a line,” the lackluster performance in Q1 should not be an indicator of mediocre performance for the rest of the year. It is too early to tell where 2024 is headed. As the interest rate environment and the global macroeconomic situation become clearer, don’t be surprised if you see an uptick in deal activity and exit events. Also, don’t forget that we are in an election year. All that dry powder sitting on the sidelines should have an impact on the level of dealmaking in future quarters. We’ll have a much better idea of the direction of the VC markets by the end of Q2.