Venture capital industry set to capitalise on low valuations amid macroeconomic headwinds

Next year could prove to be a 'vintage year' for investors who held off on investments during market turmoil, Preqin says

The venture capital industry will continue to grow over the next few years, albeit at a slower pace amid macroeconomic headwinds, Preqin says. Alamy

Fears of a looming global recession and spiralling inflation that drove the equities market rout have also affected asset valuations in private markets, opening up new investment opportunities for venture capital investor.

Although venture capital as an asset class is among most exposed to the current market turmoil, however, 2023 may prove a “solid vintage for performance”, for the industry, alternative assets industry data and analytics specialist Preqin said in a report on Wednesday.

Entry valuations have reduced significantly and competition for deals has softened amid the global economic headwinds.

The aggregate deal value slumped to $346.3 billion across the venture capital market at the end of the third quarter of this year. It is down 51 per cent from more than $685 billion achieved in 2021.

“Given that the hit to public equity valuations has impacted private markets too, there could be opportunities to put capital to work and take advantage of the fall in valuations witnessed during 2022,” Preqin said.

More managers are holding off on capital deployment amid market uncertainties as dry powder for investments at the end of the third quarter of this year climbed to $530.8 billion. It is an almost 41 per cent increase from the levels recorded at the end of 2021, it added.

The global venture capital industry’s assets under management reached $2.45 trillion in March 2022, up from $2.23 trillion in December 2021, according to Preqin data.

Over the next five years, Preqin expects the pace of growth and venture capital fundraising industry to slow down relative to sharp rises in the past few years. However, the asset class is still expected to see significant growth in total AUM, compared to other asset classes within alternative investment space, it said.

Venture capital financing for start-ups in the Middle East and North Africa rose 20 per cent annually to more than $2.3 billion in the first three quarters of 2022, putting it on track to potentially surpass the total investments attracted in 2021, data platform Magnitt reported showed.

Funding reached $512 million in the third quarter, which was the lowest since the first quarter of 2021, dragged down by global economic and geopolitical factors.

Globally, aggregate capital raised by venture capital investors increased to $221.4 billion at the end of last year, up from $102.8 billion in 2015. By the end of the third quarter VC funds raised $162.5 billion, which equals about 73 per cent of total funding in 2021, the report said.

“For capital deployed in the last two years, performance will most likely take a hit in comparison to returns seen in the previous couple of years,” Cameron Joyce, senior vice president of research insights at Preqin, said.

“However, while 2023 is not without risks, some managers will be eager to put capital to work.”

In response to the shifting market trends and price divergence, fund managers “may turn away from focusing on niche sectors and move towards sector agnostic investments”.

Early stage investments are attracting more attention and investors focused on start-ups may weather the storm better than others.

The trend is reflected in the market, with early stage and venture debt seeing the largest proportional gains in funds coming to market, increasing by 33.7 per cent and 35.1 per cent, respectively, by the end of the third quarter, according to Preqin data.