Investors in venture capital (indeed in unlisted assets generally) have experienced some headwinds recently. The recalibration of the venture sector resulting from this is not necessarily bad for new capital. Also, straws in the wind suggest that sentiment may be turning.
So, is this the time to invest in the sector?
VC darkness before the dawn?
Preqin figures showed just 174 VC funds totalling $21.8 billion closed globally in Q4 2023, making it one of the weakest quarters in a decade; Q4 was the continuation of the trend over most of 2023. In Europe, the number of funds closed shrank by a third to 505, while aggregate capital raised fell 12% to $264 billion.
Reduced activity was also accompanied by poor performance, both in venture and in growth equity. Given the fall in public equity markets over 2022, and given the lag, this was not a surprise. Preqin’s Venture Capital Index for the year to September 2023 was a disappointing -3.4% [This was in contrast to public equity, which recovered strongly over 2023.
More recent data from Pitchbook[1] suggests that the venture industry is showing resilience. Deal volumes have recovered, reversing the 2023 trend, increasing by about 19% year on year. Fund raising remains resilient, at broadly 2023 levels, not back to the levels experienced during the exuberance years but healthy.
Valuation reset
One reason is that valuations have tempered. Venture managers are being more disciplined around valuations, with many of the private market markdowns the result of public positions connected to recent IPO activity trading down significantly. Scott Voss from HarbourVest’s global Primary Investment team commented: “On the private side, we saw managers proactively make valuation adjustments that were reflective of the public market correction.” Continued valuation adjustments in turn will create more attractive entry points for the asset class.
Preqin’s Venture Capital in 2024 outlook agreed. “With more reasonable pricing now than in the recent past, this may see the 2023 and 2024 vintages have an easier time performing than the two years previous.”
Preqin quoted digital entrepreneur Tom Horsey, who launched Seville-based seed fund Eoniq to back digital ventures. Tom is now seeing higher-quality start-ups that are further up the growth curve and have market traction but are still at reasonable valuations. “It’s a very bad time to raise capital,” he said. “But it’s really quite a good time to invest it.”
All of this suggests that the outlook for venture remains healthy It could be argued that 2023 helped to blow off some of the froth from the market. A valuation reset and reduced capital (compared to the ‘go-go’ years) should help restore more pricing discipline. An environment where capital is less abundant (or perhaps even scarce) means that the clearing price for new ideas (for innovation) should be lower and returns for NEW capital higher.
This seems to be reflected in sentiment indicators. According to a recent Preqin survey, investors are increasingly optimistic about performance of the asset class over the next 12 months, with the percentage of investors expecting VC to perform better rising from 12% in November 2022 to 38% a year later.
Company innovation and disruption create new opportunities
At the same time, new company creation remains buoyant, despite the troubled macroeconomic and geopolitical backdrop, observed the HarbourVest team. Indeed, the current choppy market environment is setting up the next wave of venture disruption. “Venture capital, by investing in both intellectual property and business model innovation, can provide investors access to the future market leaders being created today,” the team added.
Goldman Sachs Asset Management’s 2024 Outlook points to the opportunities for private market capital from international political tensions and their implications for supply chains and energy. Disruption to supply chains from the COVID-19 pandemic and international conflicts have incentivised governments to onshore, re-shore or near-shore production of strategic goods. Volatile energy prices and country/company emissions reduction commitments are boosting the focus on areas such as renewable energy and battery storage.
“We think private markets are well-positioned to finance long-term sustainability investments that may require significant capital investment and time to compound, given the closed-end nature of the fund model and insulation from the quarterly reporting cycle of public capital markets,” the GSAM report authors argued. “Additionally, many opportunities in high-emitting areas such as forestry, waste and agriculture are less accessible in public markets.”
Europe’s tech start-ups in particular lead the way in climate tech, sustainability and purpose-driven investment themes such as carbon capture, consumer durables and plant-based solutions, noted HarbourVest’s Alex Wolf.
Profiting from successful VC managers
Newer VC vintage funds are well-positioned to invest in innovation and benefit from secular tailwinds such as increased technology adoption and companies staying private for longer, observed Lawrence Calcano, Chairman and CEO of alternatives markets fintech iCapital, who views the current market environment as an attractive entry point for both early- and late-stage venture managers. “These tailwinds help private companies capture a larger portion of gains than public markets.”
Provided investors put their money with those VC managers that generate the strongest performance.
As the HarbourVest team concluded: “skilful manager selection is critical to maximising expected returns of a private market portfolio – and access to top managers is especially important for venture capital, which tends to have a wider return dispersion than other private market segments and public markets.”
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[1] European Venture Q1 2024 report.
