‘Stand-off’ between VCs and entrepreneurs pushes funding volumes down

In the fourth quarter of 2022, VC investment dropped to $22.6b.

During the last few months of 2022, venture capital funding fell to levels not seen since 2017. Whilst macroeconomic headwinds played a role in this drop, experts point to the “stand-off” between the investors and the investees as the main reason for the decline.

As unicorns struggle to justify billion-dollar valuations on a fundamental basis, investors are pushing for lower valuations, whilst startups continue to hold out for higher ones. The mismatch in expectations has led to an impasse, resulting in a decline in transaction volumes and creating uncertainty in the venture capital market, Andrew Thompson, Partner, head of Private Equity at KPMG Asia Pacific, told Singapore Business Review / Hong Kong Business.

“Buyers don't believe the valuations or they prefer lower valuations. The buyers believe that the valuations have fallen, [but sellers] are still pushing for higher valuations,” Thompson added.

Bennett Lee, investment director of Velocity Ventures, said both sides of the camp—investors and startups—have not adjusted their expectations, thus the occurrence of the standoff.

“We, VCs, see the implication very quickly from the public markets, number one, but also, from our limited partners (LPs) and our extended investor network, who are managing monies. We see the implication coming very fast, and we are planning for the after-effects of it,” Lee said.

“That's why we are advising startups to be more reasonable and more realistic with valuations. We're also sharing that the funding conditions going forward will be tougher. I think startups have not felt it yet directly… Eventually, there'll be an equilibrium,” Lee added.

In the fourth quarter of 2022, VC investment funding dropped to $22.6b across 2,157 deals. 

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Thompson said the venture capital and private markets are generally undergoing a quieter period compared to 2021 also due to price changes in the market.

Thompson noted that there had been price falls in the private market due to macroeconomic factors, whilst less transparent than the price changes in the public market.

“This whole series of macroeconomic impacts started to affect the global capital markets. The public markets were down very significantly during 2022,” he said.

“Now, that uncertainty just spills into the private capital markets. I think the VC market was particularly vulnerable because you've come off this period of really quite exuberant growth,” he added.

Ben Balzer, partner at Bain & Company, had a similar sentiment, saying that “correction in public markets has important implications on portfolio company valuations and new deals.”

“We saw a strong public market correction from the end of 2021 onwards with the S&P 500 down ~25% at times during 2022. This correction has been more pronounced in the Nasdaq 100 Tech index with a drop of close to 50% at its peak draw-down. VC investments have been heavily skewed towards the tech sector in recent years,” Balzer told Singapore Business Review.

“There was a significant number of VC investments that were made at high valuations, underwriting very aggressive plans during 2020 and 2021. Similar to high-profile public market companies that have seen valuations drop by, in some cases, well above 75%, VC portfolios will also have to take a hit. The extent of this is still unclear but as this plays out, this will have important implications for how aggressive future investments will be,” Balzer added.

Thompson explained that as prices readjust to the geopolitical and economic and inflationary risk environment, traditional metrics such as revenue and profitability become “much more relevant” to VC firms.

Meanwhile, businesses, especially those who got funded quite easily two years ago, would simply not get funded at dramatically lower valuations, or what the industry calls a “down round,” a situation where a company raises new funds at a lower valuation than its previous round of funding, resulting in a decrease in the value of existing shares.

The mismatch in valuations has led to an impasse between “buyers” or the VCs and the “sellers” or the enterprises which in turn affected the transaction volumes in 2022.

Thompson, however, underscored that the funding decline is not necessarily a bad thing.
“It's just that prices are readjusting to reality, which in public markets tends to happen very quickly, but in private markets a bit slower,” he said.

More VC activity in 2023

In the first six to nine months of 2023, Thompson expects the VC market to be in a lull, with investments coming in at a slower pace.

“You’ve got the speculative type money that is largely departed and is properly less likely to  reappear and then you also have what we call the core VC community being a bit more careful about the deals, focusing more on certain business plans and waiting for better valuations,” Thompson said, adding that the first half of the year will continue to be an adjustment period for the market.

With the global fund-raising environment being significantly tighter, Balzer said new funds or less differentiated funds with an average track record will also find it harder to raise.

Moving forward, however, Thompson believes that there will be plenty of VC activity going forward.

“Historically, in private markets, the best time to invest or what we call ‘vintages’ tend to be exactly in this sort of period or the next couple of years when prices have fallen a bit lower… In fact, the best vintage in the last 25 years in private capital was 2009, following the global financial crisis,” the KPMG expert said.

“Once the investors believe that valuations have fallen to an appropriate level, you will start seeing a lot more activity ” he added.

The increase in VC activity will be seen across Asia, said Thompson.

Balzer, for his part, said China’s re-opening is another “strong positive” for the region given the “sheer scale of investment” going to the country.

Balzer said China’s closure has limited deal-making activity in Asia in 2022, with Greater China VC investment dropping by 45% relative to 2021.

What could also push investments during the year is a wider stabilising of the macro environment with lower or stable inflation and more stability on interest rates,” said Balzer.

Across verticals, Thompson expects funding to pour into artificial intelligence.

“We've all heard of the rise of the ChatGPT. Now, there seems to be a real sense that [there's going to be an enormous economic impact] from AGI or Artificial General Intelligence, where computers can do things that are roughly equal to humans, if not exceeding human capabilities,” he said.

“We suspect that we're going to see a lot of investment focused on how technologies can disrupt some existing industries, and in some cases, replace the jobs of humans,” he added.

Balzer, meanwhile, expects the healthcare industry to hold up amidst uncertain economic conditions given its “recession-proof” nature.

“Other sectors that are likely going to be more resilient will be others seen as providing essentials like Consumer Staples, Education, business-critical B2B services,” Balzer said.

In Singapore, Thompson and Balzer said FinTech will continue to be very important and relevant.

“It’s a logical place to create financial technology. There also is government support and sandbox-type regimes that have been generated [in Singapore],” Thompson said.

Overall, Thompson said 2023 to 2024 will be a year of transition for the VC market as past exuberance leaves the market valuations and terms to adjust.

“[This will lead] towards excellent investment opportunities for investors as we head into late 2023, 2024,” he added.