The Q3 2022 Pitchbook-NVCA Venture Monitor report highlighted some of the changes the venture capital marketplace is undergoing. Tightening monetary policy at home combined with war and economic instability abroad are expected to have near to medium-term impacts on the availability of capital, talent, commodities, and productive capacity across the world economy. The U.S. venture capital industry is subject to the same economic winds, but while the market has contracted somewhat from the heights of 2021, it is still performing well above historical norms.
However, there are potential challenges facing the venture capital industry on other fronts. Particularly domestic government action, monetary policy and investment trends, and foreign geopolitics.
Domestic Government Action
Over the past year, Congress has passed three significant pieces of legislation to modernize the U.S. economy — the Bipartisan Infrastructure Package, the CHIPS and Science Act, and the Inflation Reduction Act. These bills all provide incentives for VC participation, and if authorizing language and appropriated funds are managed effectively in the upcoming Congress, they could be transformative for various U.S. industries, including cleantech, semiconductors, and life sciences. More troublingly, there are a variety of regulations currently under consideration by the Executive Branch which could saddle venture-backed companies with uniquely onerous regulations when compared with larger companies in the market. Hopefully, Washington will prioritize strengthening the nation’s innovation ecosystem.
Monetary Policy and Investment Trends
As the Federal Reserve has sought to bring post-pandemic inflation under control by raising interest rates, there has been extensive anxiety by the VC community about the impact higher interest rates will have on the ability of managers to raise funds. In the short term, this has contrasted with the industry nearing an all-time fundraising record at the end of Q3 and being almost sure to surpass it by the end of the calendar year. This success has helped build up an industry-wide dry powder reserve, which totals just under $300 billion as of quarter-end. While impressive, fund managers warn that deal-making will not likely reach 2021 levels in the short term. Rather the tighter monetary environment is expected to result in increased deployment schedules and a flight to quality, with initial deals being subject to more scrutiny. Portfolio company founders will be pressed to manage their balance sheets tightly and get to revenue generation earlier to limit the need for future rounds while capital remains tight.
In 2022, history returned with a vengeance. Between the war in Ukraine, China’s transition back to autocracy, and extreme political instability in the United Kingdom, the articles of faith which drove foreign investment for the last several decades look increasingly like nostrums. This uncertainty also upends the relationships which underlay the global economy. It forces new capital expenditures on everything from commodity supply chains to manufacturing facilities. While not immune from the shocks being sent through the system right now, the size and diversity of the U.S. economy, combined with its incredibly robust capital markets and rule of law, means that the U.S. is perhaps better positioned to weather any impending storms than other economies.
Q3 2022 was a relatively good quarter for the VC industry. However, looking ahead, most of the investors we spoke with referenced the potential intersection of crisis and opportunity. When given a choice, people prefer to operate in a stable monetary environment and a world at peace. However, lacking that, most agreed that they, and the broader industry, are doing everything they can to prepare for the world as it is in hopes of pushing it toward what it could be.
Shiloh Tillemann-Dick serves as the Research Director at NVCA. His work focuses on the development of qualitative and quantitative analytical products which provide the rest of the team with the material they need to tell NVCA’s story.