The current VC market momentum and perspectives for the next few months

Rollercoaster

In early 2020, we had just announced Mindset Ventures Fund III’s first closing when the pandemic emerged and a consequent financial crisis took place. In that challenging environment, large venture capital funds adopted a conservative approach and froze investments, making the venture capital market experience a significant price adjustment and opening doors for us to invest in stellar companies under attractive conditions.

Such window of opportunities was narrower than we initially expected though, as valuations spiked shortly after they melted down, a phenomenon that can be explained by a couple of reasons. First, it is no secret that one tends to overestimate both positive and negative news, and stock prices (as well as startup valuations) reflect that short-term volatility. Second, at that particular time the same venture capital funds that decided to temporarily freeze new investments found themselves somehow under pressure to allocate capital after a few months as they needed to meet deadlines to deploy capital.

Therefore, between the recovery of the pandemic and the end of 2021, the venture capital market hit record highs in terms of capital deployment in several regions, including the US, Israel, and Brazil, and was swallowed by a single discussion: were we living a bubble? Some would even argue that the question was not whether valuations were justifiable, but when the bubble would pop. In July 2021, Forbes published an article about five reasons for which the dynamics of the venture capital market would likely keep accelerating. Although questionable in many ways (the current momentum proves so), the piece starts with an anonymous quote that perfectly synthesizes the market momentum that we were facing back there:

“We weren’t looking to fundraise, but an investor pre-empted our round and now we’re raising a $15 million Series A at a $150 million pre-money valuation on a minimal revenue. We are already oversubscribed and plan on closing the round by the end of this week.”

That euphoria didn’t last for too long, though. At the end of 2021, we faced the first signs of another downturn.

Opportunities lie in the disturbance

Towards the end of 2021, in our perception, prices were abusive with apparently no reasonable explanation aside from the fact that the excessive dry powder on the market pulled them upwards. Finding good companies to invest in has not been a problem for us for a long time, but, contrarily to what we lived over a year ago, good deals became scarce due to stretched prices. With that in mind, we decided to slow down our deployment pace and started guessing when a general market adjustment would occur.

It didn’t take much long until the first signs of a new adjustment would start to arise. With the US increasing the interest rate after a long hiatus, the macroeconomic consequences of the war in Ukraine starting to emerge, and inflation reaching substantially higher levels all across the globe, the market got into a descendent spiral penalizing publicly-traded bigtechs before any other tech company, hitting late-stage startups at a second moment, and leaving early-stage ones to the end. Amid this momentum, the market flooded with bearish news, with CNBC stating that “the good times may be coming to an end” early this year, Crunchbase News exposing the fact that venture funding fell for the first time in a year, and Tiger Global declaring the loss of 70% of everything it accumulated in the last 21 years.

By quickly analyzing the impact of the current crisis on valuations, one can verify that prices in the public market have clearly been mostly adjusted, and valuations in late-stage companies have also been largely slashed. Early-stage startup valuations, however, have just started to suffer mild cuts, but there is still space for further corrections. According to Carta, 1Q22 Series C rounds raised on average 23% fewer resources compared to 4Q21, a clear consequence of the current circumstances. Series A and B were less affected up to that point, but we won’t be surprised to see a more significant impact throughout the near future. In fact, investors once again began to have a clear edge in negotiations due to the lack of capital available for entrepreneurs. As an example, Kyle Stanford, from Pitchbook, recently stated that more investor-friendly protections should make their way back into term sheets before down rounds occur more frequently.

This scenario shares several resemblances with the pandemic context we described at the beginning of this article, which is the exact one long-term investors should look for. As we explained, at that time we managed to access exceptional deals whose results had already started to come up less than two years after the initial investment. As the market has just started to favor new investments once again, we began raising capital for Mindset Ventures Fund IV to quickly take advantage of these opportunities.

Healing the bruise

In moments when volatility rules the prices, some investors freak out and forget that the market is cyclical and that it will get back on track sooner or later. As such, the bearish momentum we are currently experiencing may take a while to end, but it will eventually come to a conclusion.

As we previously mentioned, venture capital funds must deal with a big set of variables at the same time, two of them being capital available for investments and the fund’s term. At this point, it seems most funds (mainly those limited to certain rounds or minimum amounts to be invested by deal) are becoming apprehensive to invest, waiting for the market to show its first signs of recovery to resume activities. Like what happened during the pandemic, we won’t be surprised to see excessive dry powder deployed in a short time due to the pressure of fund terms, artificially pushing prices upwards once again. Pitchbook pointed out a record collection of commitments in 1Q22 (as stated by Pitchbook on 1Q22 NVCA Venture Monitor, “many of the commitments to the funds that closed in 1Q22 were likely agreed upon during the boom times of 2021”), which should be deployed at some point throughout the next few years after the apprehension fades away.

Mindset Ventures has been preparing itself to deal with this moment for quite a while. With a robust investment process in place and innumerous good opportunities to invest at fair prices to come in the next few months, we can’t wait to start deploying capital again!