Cconsidering Puzzle below. In 2021, venture capitalists raised $150 billion in new cash, an all-time high. Despite a slowing market, they broke records again in 2022, raising more than $160 billion. Most of that has already been spent, but there is nearly $300 billion of “dry powder” waiting to be spent. In fact, spending is down throughout 2022. A fledgling company looks cheap. So why are venture capitalists sitting on cash?
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As with many other conundrums in finance, the answer begins with the rapid rise in global interest rates since early last year. Higher interest rates have sent stock values plunging as investors have moved money into safer assets such as cash and government bonds.High technical content Nasdaq The index has lost more than a fifth of its value over the past year. In 2022, the amount of money raised by stock listings fell to a 32-year low. Public market slowdowns, such as the one currently underway, reduce the expected returns for private market investors by reducing the valuations at which startups “exit” into public markets. Therefore, venture capitalists first demand lower prices in order to invest.
This especially hurts funding for late-stage startups that might be close to going public under normal circumstances. Some companies, flush with cash on their 2021 financings, chose to wait out things to wrap up, slowing down the pace of new deals. The few who continue with their plans must hope to avoid the dreaded “next round,” in which startups raise cash at a lower valuation than previous rounds — disappointing employees and early investors who are forced to face losses on their stake . At the same time, investors are increasingly reluctant to bet on riskier opportunities. They can no longer count on another backer to follow them in a deal and help it succeed with expertise or raw cash.
The second part of the answer is more subtle. In theory, venture capitalists can spend the money they have on hand. After all, it has committed to using their funds. For some firms, doing so means they also avoid losing management fees that apply only to invested capital after a period of time, not just money committed to them.
But spending at breakneck speed will almost certainly be self-defeating in the long run. Venture capitalists regularly raise capital from limited partners, such as endowments and pension funds. Many of them now want to reduce their exposure to venture capital as public markets take a hit, seeking to maintain roughly proportional allocations to different asset classes. As a result, a handful of people are calling VC funds to say “don’t rush back” to get more money, said one investor in several VC funds.
Venture capitalists are listening. Harry Nelis, a partner at venture capital firm Accel, speculates that cash that might have taken a year to spend during the market boom now takes about three times as long. Spending may become slower. The money raised by venture capital funds doesn’t actually sit in their bank accounts. Instead, when funds want to finance an investment, they must make a “capital call” to their limited partners. This forces limited partners to free up cash from elsewhere in their portfolios, something they are reluctant to do in times of stress. Funds are well aware that they will want to go back to their partners for more money in the future, so try to avoid calling at awkward times to provoke them. In fact, during the economic slowdown following the dot-com bubble of 2001, some investors even “returned” committed funds to limited partners so that their partners could reallocate the funds as they wished.
Venture capitalists have other reasons to worry about their relationships with limited partners. During the recent boom, funds have begun to think far beyond their usual fears. Sequoia Capital, a well-known Silicon Valley institution, has launched a “super fund” that includes investments ranging from traditional venture capital interests to public market stocks. Some LPs think the scope of this type of fund is ridiculously wide, but choose to buy to get a professional fund anyway. No wonder venture capitalists are now hitting the brakes and looking to repair relationships with limited partners. At least as long as market conditions remain dire, the industry’s ambitions to conquer the world will be put on hold. ■
Learn more from our financial markets columnist Buttonwood:
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Are investors in for another bad year in 2023? (January 5)
India’s stock market is roaring. They also have serious bugs (Dec 20)
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