Have Venture Capital valuations peaked? How do valuation movements affect me as an investor and entrepreneur?

Over the last decade, there has been a continued upward trend in Venture Capital valuations, especially in the U.S. During the period 2021-2022 (post-pandemic years), the process was even more pronounced.

This trend emerged in the private environment and public financial markets. The so-called organized markets have seen generalized rises in almost all the main stock market indexes. However, there was a correction in the second semester of last year.

Variation of principal world stock market indexes from 2012 to 2022

Index CAGR Increase
S&P 500 12% 3.11x
Nasdaq 15,2% 4.12x
Euro Stoxx 50 5,2% 1.66x
Nikkei 225 12% 3.10x

The question is, what is the reason for these increases in Venture Capital valuations? More importantly, what is the current trend?

First of all, we analyze the behavior of the early-stage funding rounds of a company, i.e., most commonly found on an equity crowdfunding platform such as Fellow Funders.

Pre-money valuations of early-stage companies

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Source: Pitchbook Data Inc. | Geography: Europe

Taking into account these companies, we can determine that:

1) There is an uptrend in the valuations of this asset class.

2) There has been a significant rise in 2021, especially in 2022.

3) There is a notable increase in the valuation dispersion of the different companies.

What is the reason for this effect?

In our opinion, multiple factors could explain the increases in the companies’ valuations in the earliest stages of activity in the last decade. We must consider both extrinsic factors to companies that are directly related to the economic situation and regulation (low-interest rates, regulation changes, technological changes, etc.), as well as company-specific factors that relate to the innovation capacity of startups and their increasing professionalization in advance of their scaling.

All these factors have led to a significant increase in capital allocated to alternative investments, generally, and to startups in the early stages or scaleup process, specifically. The increase in available capital and the number of potential investors has meant that companies can raise more funding, thus increasing the round sizes. This process has resulted in entrepreneurs maintaining their participation at the cost of higher valuations of their companies, which may have a negative impact on the development of future rounds.

Round size

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Source: Pitchbook Data Inc. | Geography: Europe

Are all the sectors equally affected?

Over the years analyzed, we can see that a similar percentage has been maintained in the distribution of operations in this type of company, highlighting a clear predominance of software companies, representing almost half of the funding rounds.

One important aspect to note is that, in the last two years, verticals such as Fintech and cryptocurrencies/blockchain companies have also had a great influence, being among the most significant valuation increases. So, although the rise in valuations is present in almost all sectors or verticals, we can say there have been differences between them.

Variation in median pre-money vertical valuation from 2012 to 2022

Vertical Increase
Fintech 3.27x
Healthcare 2.76x
E-commerce 3.23x
Crypto/blockcahin* 4.34x

*The crypto/blockchain data corresponds to the period from 2014 to 2022.

Source: Pitchbook Data Inc. | Geography: Europa

What is the current trend point? Have we reached the top?

The stock markets suffered a core correction in the second semester, mainly due to high inflation and the consequent interest rate hikes by the Central Banks. As a result, there has been relative uncertainty about the macro situation and even an economic recession, whose depth and scope we do not yet know. These corrections have particularly affected the so-called growth companies, which share many similarities with startups. So, it seems logical to ask, will this correction be the same in Venture Capital?

Unlike in listed and public markets, we can only obtain real data on market valuations in private markets, such as Venture Capital, when transactions are carried out. Faced with a scenario of uncertainty similar to the current one, we can see that Venture Capital is slowing down and even paralyzing operations, especially in large operations or mega-deals, carrying out those previously being worked on and reducing the pace of new investments. This effect is much more noticeable in the USA, the real driver of these operations.

Invested capital in Venture Capital Europe

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Source: Pitchbook Data Inc. | Geography: Europe

We should also consider that although the rise in interest rates could mean that some investors will not allocate part of their capital to alternative investments due to the increase in profitability of traditional investments, Venture Capital funds are currently at historical highs of dry powder, which is the name given to the capital available for investment. Therefore, we can not determine that, in the short term, there will be a change in the amount invested if the current stage of uncertainty is overcome, which, logically, could affect inflation in the valuations of their investees.

However, we should highlight the presence of some decreases in the valuations of larger companies in Q4 2022, which, being closer to a possible exit, are affected more quickly by these market variations, suggesting some symptoms of market depletion.

What can we expect in 2023?

After analyzing the different exogenous macroeconomic factors and the specific factors of Venture Capital, we forecast that 2023 will maintain or slightly decrease the valuations of this asset class. In our opinion, we believe that this type of investment will continue to attract increasing amounts of long-term capital available for investment, given the expected returns and the development and scaling of the newly proposed business models.

As for final investors, we can assume that returns appropriate to the levels of risk assumed can continue to be obtained since these returns are directly related to the growth of the companies invested. In this sense, the leaps in valuation between rounds are likely to continue to occur and be favored by the vintage effect. As a result, it is possible that 2023 could prove to be a good year for Venture Capital investment.

However, how will this effect influence investors and entrepreneurs? We will answer this question in future issues.

Juan Sánchez Margareto
Senior Analyst

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