Young startups are feeling the pinch as seed funding succumbs to the VC winter
- Funding rounds for seed startups fell for the fourth straight quarter, according to Carta data.
- These fledgling companies had been insulated against the ripple effects of the stock market crash.
- Some megafunds and solo venture capitalists are slowing down, making it harder to get capital.
For the past 16 months, seed-stage startup funding has been a rare bright spot in an otherwise bleak venture capital landscape, which has seen a sharp drop in investment. However, data and experts indicate that this is no longer the case.
Carta recorded 441 seed rounds in the second quarter of this year, the slowest quarter for deal activity since early 2019. This is a 41% decrease from 745 transactions in the same period last year. Not only is the number of seed rounds decreasing, but total cash raised has also decreased to $1.6 billion last quarter, down from $2.9 billion in Q2 2022.
Those figures point to a harsh reality for the most vulnerable startups, which had previously danced around the initial fallout of the funding drought. They’re now competing for investment as more founders pitch for new funding this fall, and the pool of willing backers appears to be shrinking.
Jenny Fielding, a general partner at Everywhere Ventures and a super-connector on the New York tech scene, said founders and investors sent her more than 70 deals to review in a single week in August. She joked that she’s either very good at her job or that funding for early-stage companies is becoming more difficult to come by.
“So many people are coming to me because their options are getting fewer and fewer,” Fielding explained. “The usual suspects are all tapped out.”
Startups are feeling the pinch as investors ranging from megafunds to solo venture capitalists adjust to a new fundraising environment.
‘The tourists have gone home’
In the early days of the pandemic, venture firms known for later-stage investments poured into the seed market. They sought to secure lower-cost stakes in the most promising startups as soon as possible, so they could keep an inside track on the hottest companies as they grew. Investing earlier in the process is riskier, but it provides the opportunity for larger profits. Firms such as Andreessen Horowitz, Sequoia Capital, and Greylock Partners attempted to go even earlier, raising more than $1.1 billion in three dedicated seed funds in 2021.
However, the honeymoon period did not last. Their enthusiasm began to wane as rising interest rates and rampant inflation caused the value of publicly traded technology stocks to fall in 2022, and the correction reverberated into the private markets. The pace of dealmaking slowed, valuations fell, and startups could no longer rely on funding from venture firms flush with cash and hedge funds hoping to be among the first to invest in the next Airbnb. The crash forced multistage firms to engage in portfolio triage, putting money aside to bolster their existing businesses.
“A lot of multistage firms that had been playing in this space for a while have realized that they need to focus on their core, so they’re not making as many seed investments,” said Marlon Nichols, cofounder and managing partner at MaC Venture Capital. He also mentioned that dealmaking tends to slow down in the summer.
According to Lily Lyman, a general partner at Boston venture firm Underscore VC, “the tourists have gone home.”
Founders are also concerned about the lack of emerging investors, such as solo capitalists, super angels, and first-time fund managers. Multiple investors have stated that these people are slowing down because it has become increasingly difficult for them to raise new funds. They’re doing fewer deals to stretch their last funds further, into 2024 or 2025, when fundraising conditions may improve.
“Fund managers like us, we know how difficult it is to raise money,” said Brian Sugar, who recently closed a $33 million venture fund. Sugar Capital had planned to raise $75 million for the fund, its second, but Sugar reduced the target size last summer.
“If you have $25 million left in your fund, you want to make that last until the market improves,” Sugar explained. “It’s healthier investing when you’re really, really taking your time placing your bets, because capital is scarce everywhere.”
Extensions abound
Capital supply is dwindling while demand is increasing.
According to multiple investors, this is due in part to an increase in the number of seed startups attempting to raise extension rounds. When capital becomes scarce, many companies delay raising their next priced round in favor of doing an extension, which is when a company closes new funds, usually from existing investors, on the same terms as the previous round. According to Peter Walker, Carta’s head of insights, extension rounds are taking a larger share of seed funding, accounting for 40% of seed rounds on Carta in the second quarter of this year.
“There are more companies than ever that need that extra cash in order to keep runway alive and make it to the next milestones, and so investors, instead of having to have that extension conversation with say, 20 or 25% of their portfolio, they’re having it with 60% of their portfolio,” he said. “And then they have to decide which of their portfolio companies we are going to double down on?”
Insider first reported in August that lending startup Captain is closing down after failing to raise an extension round from existing investors this spring. The two-year-old company had previously raised $107 million in equity and debt financing.
All of this points to a Darwinian moment for startups, with hundreds of startups facing extinction. However, it is not all bad news. According to Carta data, the median seed valuation reached $13.7 million in the second quarter, significantly higher than any quarter prior to 2021. This figure has been boosted by artificial intelligence startups, which can command extremely high valuations even during a downturn.
“The founders that are raising seed rounds are raising them for decent cash and at decent valuations — healthy on both fronts,” said Carta’s Peter Walker. “There are fewer of them doing it.”
