At the end of 2022, investors and entrepreneurs felt a palpable decline in venture capital deals and fundraising activity. Now we have the data. According to Pitchbook, less than $10 Billion in exit value was generated in Q4 for the first time since 2013. Overall, U.S. VC exit activity totaled 1,208 deals valued at $71.4 billion in 2022 versus 1,925 deals valued at $753.2 billion a year earlier — decreases of 37% in deals and 91% in capital. In parallel, venture capital funding declined by 35% while IPO’s declined by 31% and unicorn valuations experienced an 86% YOY decline during the fourth quarter of 2022.

Source: Pitchbook

With the sharp decline in deal activity towards the end of last year, how will this affect the VC environment into 2023? PORTAL’s Managing Partner and 20-year VC veteran, Peter Loukianoff, has seen tough times like these in venture capital present opportunities for investors prepared to take advantage.

Source: Pitchbook

Nurturing Current Portfolios

VCs have had to pause new investments in order to reevaluate their current holdings — many of which may now appear to be held at overly-priced valuations. More than ever, times like these force venture firms to triage existing portfolio companies and assess which ones need to be abandoned and which ones will continue to get support going forward. Loukianoff opined, “In order to maximize returns in their overall fund portfolio, VCs may need to cut off future funding for marginal companies in favor of those that, in their current judgment, have the best chance of success. Investors will need to put more of their reserves behind a fewer number of companies in their existing portfolio. But, this is easier said than done. Prior investments are sunk costs. Each new investment must be made on its own merits ignoring prior investments. If those companies require restructuring they may not be as attractive going forward.” In this sense, the bar is also higher for competition between existing portfolio companies for scarce fund reserves. During economic downturns, VCs try to cull their portfolios to concentrate their remaining fund reserves on fewer companies that can outperform. “A lot of time is now being spent on budgeting, re-forecasting, and stretching existing cash as long as possible. Boards are cutting fat and doing detailed bottoms-up analyses of every aspect of a business. They are asking “what and who do we really need?” They are figuring out how to get 18–24 months of runway.” If history is a guide, prepared investors with fresh capital can find extraordinary opportunities under such conditions.

Less Competition, Lower Valuations = Better Deals

For investors with fresh cash, there is less competition in the market right now to get into great deals. The question is who will win these deals and what is considered a great deal?

New funds and those unencumbered with an existing portfolio of troubled companies have the best chance of winning. Legacy funds that raised capital in mid-2022 will probably start to increasingly deploy their capital closer to Q3 of this year as many of them are focused on triage today. The first half of this year will be an opportune time for investors to find value in companies that could emerge from this downturn to be the next unicorns.

As far as what is considered a good deal, Loukianoff shared his perspective on what he previously saw between 2008 and 2009. “Following the 2008 financial crisis, my fund was able to get into mature Series C level companies at Series A valuations. One of them produced an IRR over 1,000% and the overall risk-adjusted returns in that period outperformed, which is why I think 2023 will present similar opportunities for strategically minded investors.”

Getting Access

While such opportunities are available, the challenge for individual investors is getting into the best deals. “VC is not just an asset class, it’s an access class,” explained Loukianoff. “VC funds have become overly institutional and essentially shut out individual investors. We started PORTAL to provide influential individual investors access to attractive startup investments alongside top-tier VCs — giving them the same opportunities as institutions like pension funds and endowments.”

A Wild Card Year Ahead

“Although uncertainty remains about the health of the US economy in the midst of wider potential macroeconomic headwinds, the VC industry may see a boost by summer due to the large amount of capital that was raised through Q3 2022. Time will tell, but we may look back at the first half of 2023 as one of the better periods for venture capital investors since the great recession of 2008.