Cloud of uncertainty drives down US venture capital investment for third straight quarter

A dramatic shift in the relationship between startups and investors has emerged over the last few months given the challenging market conditions and significant downward pressure on valuations. While there continues to be a robust amount of dry powder in the market, venture capital (VC) investors in the US have grown more cautious and selective in their deal-making activity, scrutinizing deal terms more rigorously than in recent years.

According to the Q3’22 edition of Venture Pulse, a quarterly analysis by KPMG Private Enterprise, US VC investment fell to $43 billion—the lowest amount since Q2’20—amidst ongoing concerns related to high inflation, rising interest rates, and a US recession, in addition to uncertainty related to the midterm elections scheduled for Q4’22. 

Despite the challenges permeating the US market, several companies raised large funding rounds during the quarter. Industries including energy, business productivity, healthcare and cybersecurity are expected to remain relatively resilient heading into Q4 2022. Key takeaways are highlighted below.

Venture debt deals on the rise

During Q3’22 interest in venture debt grew in the US as a means to obtain capital without raising new funding rounds. The greater interest in debt financing came both from startups looking to avoid down rounds and from investors not willing to provide new tranches of money to their portfolio companies and wanting to avoid diluting their capitalization.

US exits non-existent in Q3’22 as companies try to wait out uncertainty

Exit activity in the US was incredibly soft in Q3’22, with just $14 billion in exit value —a level not seen since Q4’16 —as IPO activity continued to be non-existent in the wake of the volatility in the public markets and ongoing concerns related to valuations. M&A activity was also quite slow during Q3’22. While the depressed valuations environment has led to increasing interest from PE firms and corporates looking to make deals, startups that may have been ready for an exit earlier in the year are likely trying to wait out the uncertainty with the hope that valuations will bounce back.

Growing number of SPACs calling it quits

Interest in SPACs has faded over the last 12 months, resulting in questions about whether the robust number of US-based SPACs initialized during 2020 and early 2021 would be able to find targets before their two-year deadlines. While a number of these SPACs are working to extend their deadlines, an increasing number are sending refunds to their investors.

Trends to watch in Q4’22

With the turbulent market conditions expected to continue in Q4’22 and into 2023, VC investors in the US will likely remain very cautious when making deals despite the availability of dry powder. Corporate valuations will likely remain depressed, while the number of companies holding down rounds will likely increase.

From a sector perspective, VC investment is expected to remain relatively resilient in areas like energy, business productivity, cybersecurity, and healthcare, while interest in food and grocery delivery, consumer and retail, and eCommerce is expected to fall.

M&A activity in the US is well positioned to increase over the next quarter or two as companies fail to attract new funding and PE investors and corporates look for good deals. Should the IPO window remain firmly closed, some companies that may have been preparing to hold an IPO earlier in 2022 could decide to sell instead.

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