Aug 9, 2023
The fundraising drought seems to finally take effect on early stage companies.
In the fast-paced world of entrepreneurship, staying informed about market trends and shifts is vital for making informed decisions. One critical aspect that has garnered considerable attention in recent times is the valuation of companies. As an attorney specializing in business and corporate law, I aim to provide you with valuable insights into the evolving landscape of company valuations, drawing from the findings of the PitchBook VC Valuations Report.
Seed Stage Cooling Off
The initial seed stage of startup financing is experiencing a notable shift, as highlighted in the PitchBook VC Valuations Report. Both at the median and top decile, deal size fluctuations over the last 12 to 18 months have been fairly negligible, suggestive of investors' reluctance to overzealously commit capital and their desire to see capital-efficient milestones achieved. In Q2 2023, the median early-stage valuation step-up hit a near-decade low of 1.6x. This trend implies that the seed stage's summer may be cooling off early. Entrepreneurs should be mindful of this trend when considering their initial valuations.
Nontraditional Investor Retreat
The PitchBook VC Valuations Report also sheds light on the retreat of nontraditional investors, including corporate venture arms and sovereign wealth funds. In the first half of 2023, only $62.9 billion of US VC deal value involved nontraditional investors, a decline from $122.4 billion in the first half of 2022. Nontraditional investors historically influence startup valuations, with deals involving them having higher median valuations compared to those without. However, these valuations have decreased significantly from previous years. The departure of nontraditional investors from VC has resulted in a scarcity of capital for startups, giving investors more leverage in negotiations and leading to potential further declines in valuations.
Late-stage startups, as they approach pivotal growth milestones and contemplate exit strategies, are encountering their unique set of challenges, as outlined in the PitchBook VC Valuations Report. In Q2 2023, the 2023 YTD insider-led deal proportion reached 9.4%, the highest point observed in nearly a decade, attesting to the capital shortage and investors’ unwillingness to take on financing risks. A slight QoQ uptick in the median late-stage VC valuation signals a flight to quality, where GPs are exercising caution and deploying capital only to the highest-quality companies demonstrating strong growth momentum. Entrepreneurs aiming for late-stage funding should be prepared for a challenging financing and public exit environment.
The PitchBook VC Valuations Report highlights the overall venture funding environment, which is currently leaning in favor of investors. The percentage of down rounds has ascended to a four-year high due to limited capital availability resulting from a pullback of nontraditional investors, as well as a flight to quality when investors evaluate investment opportunities. GPs have been leveraging their negotiation power to ask for more-investor-favorable terms in term sheets, including larger equity stakes, higher liquidation multiples, and cumulative dividends. Entrepreneurs should carefully negotiate and assess the long-term implications of such terms when raising capital.
Uncertain Exit Environment
The IPO landscape remains challenging, with limited public offerings, marking the slowest period since the global financial crisis. Additionally, M&A activity has declined. The uncertain exit environment raises concerns for entrepreneurs planning exit strategies. Careful consideration of alternative avenues and preparedness for extended timelines may be essential in navigating this landscape.
Venture-growth-stage startups, which typically prioritize rapid growth over profitability, are encountering distinct challenges, as highlighted by the PitchBook VC Valuations Report. In the first half of 2023, the median pre-money valuation for venture-growth startups plummeted by 64.3% compared with the record high seen in 2021, dropping to $125.0 million from $350.0 million. Understanding these dynamics can help entrepreneurs make informed decisions regarding their growth trajectories.
The Role of Nontraditional Investors
Nontraditional investors have historically played a significant role in influencing deal metrics and startup valuations, as emphasized in the PitchBook VC Valuations Report. However, their reduced participation in the venture ecosystem may lead to more competitive negotiations and potentially lower valuations. Entrepreneurs should adapt to this changing landscape by carefully evaluating financing terms.
The findings from the PitchBook VC Valuations Report suggest that the startup funding environment is likely to remain challenging for the foreseeable future. As a business and corporate attorney, I recommend that my clients stay informed, adapt to evolving market conditions, and carefully assess financing agreements. While challenges exist, they also present opportunities for entrepreneurs to innovate and thrive in this dynamic environment.
In conclusion, the landscape of company valuations is evolving, impacting entrepreneurs at various stages of their business journeys. Staying informed and seeking expert legal guidance is essential for making sound decisions that will shape the future of your business, drawing from the valuable insights of the PitchBook VC Valuations Report.