Venture Capital Benchmark Q4 2022
US, Europe, AND Latin America
A Market in Transition
Q4 2022 proved to be a quarter of transition. If you saw our last quarter’s Benchmark Report, you would have read about drops in funding volume across the board; no geography or stage was spared. One can draw many conclusions as to why this occurred: excessive quantitative easing, flood of capital in the market due to COVID, rising interest rates as a response to out of control inflation, geopolitical tensions, etc. Whatever you attribute the causes to, the effects were cascading; public equities took a nosedive in Q1 2022 and capital from nearly every asset class quickly retreated. This market is unlike others in the past, as 2022 was the first time since 1969 where the S&P 500 and the Bloomberg US Aggregate Bond Index both ended in the red. We saw this capital retreat play out over the course of quarters in VC, with the major effects hitting early stage and seed VC deals in Q3 and Q4 2022.
There is certainly reason for pessimism in a market like this one. Startups and investors alike are feeling the pain in their bottom lines and return metrics. However, we also see plenty of reason for optimism due to the opportunity in front of us. In stark juxtaposition, as investors retreat from capital markets, we have observed founders and operators digging their heels in and building incredible companies and realizing extraordinary technology advancements. This paradoxical combination generates a once-in-a-decade opportunity for patient investors with dry powder. Not in recent memory have there been so many qualified founders building game-changing startups at such attractive valuations. Combine that with many market incumbents likely to fail and massive advancements at the intersection of science and technology (to be covered later, mainly in AI), and you arrive at a perfect storm for true disruption.
Bill Gross, prolific startup builder, investor, and founder of Idealab, ranked the key ingredients of startup success in his TED talk. Many of these are core focal points of every VC fund investment memo: team/execution, idea outlier, business model, amount of funding. However, one that is often overlooked, and what Bill found as the biggest driver of startup success, is timing of the company’s arrival. A company that exemplifies that driver well is Deel, an HR platform for companies with international teams, which increased revenue from $4M ARR at the beginning of 2021 to $295MM ARR 2 years later. Much of this growth was attributable to the timing of COVID, which helped Deel recently close a round at a $12B valuation after being founded in just 2019. We believe today’s market conditions provide unique timing for founders across many industries to build generational companies.
Welcome to our quarterly VC Benchmark Report, where we analyze all of the startup and investing activity over the past 3 months and stack it up against what we saw in the previous quarters and years. We scan across the US, Europe, and LatAm to bring you the best insights, be it you are an investor, founder, or just interested in the startup investing space. Let’s dive right in.
VCs shift priorities and workflows
The messaging circulating VC circles in Q4 surrounded supporting portfolio companies operationally, prolonging runway through extension rounds to survive until more favorable market conditions materialize, and fundraising to take advantage of favorable valuations.
Funding volume and deal count contracted to $52.5B across 5,683 deals (-23% QoQ decline, -57% YoY drop), VC-backed exit volume in Q4 slowed to $5.2B, a 10-year quarterly low, while 2022 recorded the highest amount of capital raised by venture funds ($163B).
The inferences drawn here are relatively clear. VCs have withdrawn from the market for a multitude of reasons and have instead focused on their existing portfolios. They are planning to deploy capital in large sums in the coming years, but are waiting for the storm to pass before doing so. We will likely see increased IPOs and M&A as indicators of more optimistic equity capital market conditions, but those will be predicated on investors rotating out of interest-bearing assets (debt) into riskier assets.
Our co-founder, Clara Bullrich, has witnessed several market cycles across multiple asset classes in her tenure as a seasoned private and public markets investor and startup founder. She provides her thoughts on what we saw in 2022 and what to expect in 2023:
Clara provides a great perspective on what 2022 brought and things to expect moving forward. We are excited to back the next crop of amazing founders in 2023.
We agree with the sentiment from Howard Lerman, founder of Yext (NYSE: YEXT) and Roam, many of the greatest founders of the next generation are building companies today as the market gets flooded with top product and engineering talent. The companies that survive, manage cash, and build sustainable business models in these economic conditions will flourish once capital becomes more readily available. Founders now more than in previous years are pressured to build products that customers deem “must haves” as opposed to “nice to haves” due to the higher standard they are being held to for capital raising. Founders need to brace themselves as they continue to execute and hit KPIs:
Extend runway by any means necessary. Cash is king in this market and it cannot be overstated how important having a war chest can be to flexibly navigate these times. We have spoken to startups that are in scale down mode in order to survive, and others that are in scale up mode who have large cash reserves and see this time as an opportunity to seize market share when others are retreating.
Focus on profitable unit economics. Understanding your customer’s willingness to pay, lifetime value, and cheapest method for acquisition are paramount for success. Something we focus on at TheVentureCity when evaluating our portfolio is cohort retention and user engagement. Understanding how different customer cohorts interact with your product can help you tinker and adjust to accelerate product-led growth and eventually reach product-market fit. We are so passionate about this type of analysis that we built the growth scanner to specifically help us and our portfolio founders understand which growth techniques are successful.
Believe. This may sound cliché but undying belief and perseverance by a founder that they will realize their vision can be the difference between success and failure. Inspiring this belief in your team that brighter times are ahead can be the motivator to keep pushing every single day. Businesses are more than products and P&Ls, people ultimately determine the outcome of early startup success and those people will be tested in this market like nothing we have seen in the past decade. Keep the faith!
Let’s Look At The Numbers...
Q4 a continuation of Q3
What we saw in Q4 2022 was much of the same in Q3 - investors pulling back from the market in broad strokes and the largest startup funding market, the US, feeling much of that pain. Q4 produced $42.7B in deal volume across 3,858 deals, a -13.6% decrease QoQ.
While not a monumental change from Q3, this represented a -57% decline YoY. Q4 2021 saw the most VC capital deployed ever to be fair, however it’s clear investors are being more judicious with capital placements as they deploy into only the best opportunities, support their portfolio companies at all costs, and lick their wounds and wait for more favorable fundraising markets.
Our General Partner and former founder in his own right, Andy Areitio, has a unique perspective on fundraising as he has seen both sides of the founder-investor table. He provides his views on how VCs will deploy capital going forward based on the macroeconomic environment we are in:
Q4 slips further from the records set in 2021
2021 proved to be Europe’s VC coming out year. Deal count increased YoY from 2020 by 21% and deal volume more than doubled. Clearly capital poured into Europe at a pace never seen before where rounds got larger and international funds entered the market at increasing rates
The beginning of 2022 started out the same way, however Q3 saw slippage and Q4 performed poorly.
Q4 2022 produced $12B in VC funding across 2,133 deals, which represented a -42% drop QoQ and -57% decline YoY.
Jaime Sendagorta is a Madrid-based Director at GP Bullhound and works closely with entrepreneurs across Europe. He comments here on the shifting priorities for investors and how they are approaching deploying their large capital reserves in this market environment:
Even when European deal volume dropped, capital commitments continued to pour in
Even when European startups themselves suffered in Q3 and Q4 2022 compared to prior quarters, the same cannot be said for European VC funds. Less funds raised a record amount of capital last year: 212 funds raised €25.4B, an average of €120M/fund.
2021 set a record at the time with European funds raising €25.3B, but average fund size was less at €83M/fund.
This creates an interesting narrative: despite different startup fundraising environments, VC funds have still been able to attract LP commitments at increasing rates.
After declining performance the prior three quarters, Q4 rebounds
Latin America felt the effects of the market pullback in major ways throughout 2022. Q3 and Q4 2021 saw tremendous interest in the region highlighted by a few landmark deals that created major buzz around startup activity in LatAm.
However, as the market retreated, so did VCs and LatAm startup funding suffered. However, while most regions still continued to suffer in Q4 2022, LatAm surprisingly saw a rebound to $1.7B across 183 deals. This represented a 53% increase QoQ and a -111% decrease YoY.
We don’t let short-term fluctuations in fundraising volume impact our thesis on the LatAm region. Over the course of quarters and years we watch major investors dive in and pull back from the region based on market dynamics and LP sentiments.
We maintain a long-term perspective on the region that amazing entrepreneurs will continue to bring new technology to the region that is ripe for disruption as LatAm enters the digital age at a rapid rate. We realize there remains constant risk associated with LatAm as a whole, such as political instability and currency fluctuation, however as seasoned investors we understand innovation in the region has continued to persist despite factors that founders cannot control.
We have been long-term investors in LatAm and continue to be excited and optimistic about the opportunities emerging from the region.
Fintech continues to be the major industry driver of VC dollars in LatAm, a vertical we know well through our experience working with our LatAm fintech portfolio founders.
Inflation is out of control in many countries in LatAm, sowing the seeds for mass crypto adoption as a better alternative to native currencies.
Certain countries such as Brazil, Mexico, and Colombia have large, rapidly growing markets that are underpenetrated by tech. We continue to focus on these countries due to the large opportunities inherently available there.
Latin American founders are inherently used to operating with scarcity for resources. They are persistent and austere by nature, which plays to their advantage in this market where capital is less available.
Florida sees drop in funding from Q2 all-time high
Florida was a beneficiary of unprecedented growth due to favorable market conditions and companies moving operations to the region due to COVID. As a result of this, funding volume in Q2 2022 nearly tripled from the prior year (Q2 2021).
However, this trend has since reversed due to the general market pullback and the collapse of crypto markets. Q4 2022 ended the quarter with $645M deployed across 137 deals, a -63% decline QoQ and -61% drop YoY.
Despite this unfavorable reversal, 2022 has still been fantastic and we are still bullish about Florida’s startup presence and Miami as a growing hub for tech talent.
There are many leading factors that can plausibly predict future startup activity. Despite a drop in fundraising activity over recent quarters, the volume of founders in an area and hiring activity are often leading indicators of future increases in capital deployment. Daniella Levine Cava, Mayor of Miami-Dade County, has her finger on the pulse regarding new company formation and hiring activity, and highlights these drivers as forces for startup activity moving forward.
“Miami-Dade continues to be a hub for innovation and startup activity, despite a nationwide market pullback in 2022. If you double click on Miami-Dade, you'll find that some of the most exciting startups are based right here in our backyard, and we’re welcoming more entrepreneurs year after year,” said Mayor Daniella Levine Cava. “The COVID-19 pandemic forced the industry to adapt, but it’s clear that the diaspora of tech talent to new hubs like Miami-Dade has proven to be permanent. We will see the ripple effects of this major talent migration as today’s startups grow into tomorrow's fortune 500’s - hiring large volumes of local talent and raising impressive rounds of capital.”
Spain sees flat funding QoQ and larger deals
Spain was one of the few geographies immune to disruption in the VC funding markets. Dollars deployed remained relatively flat at $681M across 120 deals compared to Q3’s $677M.
However, Q4 produced an average deal size of $5.7M, up from $5.3M/deal in Q3 and $3.8M/deal in Q2. This continued trend shows Spain remains a resilient and fertile region for startup activity where investors have shown continued interest in deploying capital.
Within Spain, Madrid continues to be a focal market for us. We observed Q4 produced notable large rounds for exciting emerging companies, all hailing from Madrid.
Stratio (AI for augmented data governance and data analytics, $98M at $394M valuation), Cobee (flexible HR benefits, $64M at $169M valuation), and SmartRental (hotel network for a variety of stay accommodations, $26M round).
Over the past year we invested in Devengo’s (Instant Payments API) seed round and followed on in our portfolio company Plexigrid’s (reinventing electricity grids) Series A round. We continue to be impressed by the talent emerging from Madrid and the founders we meet from the greater city area. We are committed to continuing to be an investment leader in the region and supporting companies in our backyard.
Brazil rebounds in a big way
After three quarters of contraction, Q4 shows reason for optimism
In 2022 Brazil was one of the first regions to show signs of the VC market pullback.
After 3 consecutive quarters of strong growth in the later part of 2021, Q1 - Q3 in 2022 showed a steep downslope of startup fundraising where investors withdrew from the region in a meaningful way.
However, Q4 told a different story. Q4 2022 produced $1.1B across 100 deals, 97% higher than Q3’s funding volume.
Ricardo Sangion, our Partner located in Sao PauloBrazil, has his finger on the pulse in the region as he works closely with countless early stage startups across the country. He shares his thoughts on the state of the market in Brazil:
Women in VC
More work to do to achieve gender parity
Female US co-founded startups (minimum 1 woman on founding team) only received $6.3B in VC dollars across 708 deals in Q4 2022. That represented only 15% of all funding volume for the quarter, down from 18% in Q3.
On the bright side, 2021's average proportion of VC dollars allocated to female co-founded companies of the total was 14.8% and 2022 was 15.9%.
However, for female-only founder teams, progress retrated. In 2021 investors deployed 2.4% of all VC dollars into female-only founded companies, and that figure retracted to 2.0% in 2022. Clearly more work to achieve funding parity needs to be done.
This comes in the form of investors supporting female founders at a higher rate and encouraging more women to found companies.
We continue to be excited to invest in the next generation of female founders. We are constantly inspired by the quality of female talent in the market, which stands to only grow with recent tech layoffs prompting female product and engineering leaders to take the leap and build the companies of tomorrow. Founders like Shuo Wang (Deel - $12.4B valuation), Cristina Fonseca (Talkdesk - $10.4B valuation), and Lucy Guo (Scale AI - $7.3B valuation, currently building Passes) have built impressive unicorns, and we look forward to backing the women who will build the next ones.
Portfolio Company Spotlight
Del Alfonso walks us through his fundraising experience
Del Alfonso from Harmony recently closed a seed round at the end of 2022. He learned many lessons through this process, and was gracious enough to share them with other founders curious about what a fundraising process entails in this current market environment.
Del gives great insight into the reality for many founders right now; fundraising is hard. However, founders can make a difficult situation easier by preparing in the correct manner. Some key takeaways from Del’s comments include:
Do your homework. Investors want to see proof you are solving a real problem and your solution has been tested to solve that problem. Investors want to be convinced the problem you are solving for is a “must have” and is big enough to justify a huge need in the market. Regarding proof your solution is feasible, that can come from traction, user research, expert validation, etc.
Professionalizing the team. Inventors look at the caliber of initial hires as a sign of a founder’s ability to recruit quality talent and what they are building is important. Building out a team that are experts and high performers in their fields who are primed to execute on the ultimate vision is key for raising capital early on.
Highlight market drivers. Harmony benefited from the national baby formula shortage as a tailwind for the urgency of the problem they are solving. Founders can “create their own luck” by magnifying the importance of the problem they are solving based on what the market is demanding. This often requires research and user interviews if the problem they are solving is not making national headlines.
Data Deep Dive
Navigating choppy market conditions requires a strong understanding of one’s users
We have built our investment thesis and perspectives on investing at TheVentureCity precisely for times like these. When markets pull back and capital is being circulated less quickly, consumers curb spending and eliminate unnecessary costs. Our VP of Data & Analytics David Smith comments on how startups should approach this changing environment:
David gives some great insights into how startups can adjust in this market climate:
All spending and investment should be from a survival mode mindset. The companies that grow to be huge in the long-term have to survive market swings and outlast competitors and new entrants. To do this, they have to focus on their users and retaining them at all costs.
David provides examples of what founders can expect from new growth during these periods. To outlast market headwinds and declining acquisition rates, founders can revisit their pricing models and other levers they can pull to maximize retention from power users they need to maintain within their bases.
Diving deeper into the stages tells us what’s happening at ground level...
Seed rounds slide
Companies at the seed stage benefited greatly from capital flooding the market towards the end of 2021. We saw a sharp uptick in deal volumes and average deal sizes in Q4 2021 and into Q1 and Q2 of 2022. However, this trend quickly reversed as public markets and late stage private markets began feeling the pain of money leaving the system.
Investors retreating and rotating into interest-bearing assets and cash became apparent at the seed stage in Q3 2022, and certainly in Q4 2022. Q4 produced $5B across 1,225 deals, -29% down from a quarter ago and -32% decline from a year ago. What is also interesting is the perception at this stage from investor and founder perspectives.
Despite the pullback by investors over the past couple quarters at the seed level, we remain optimistic and excited about the prospect of investing in founders at this stage. Our Partner, Cesi de Quesada Covey, breaks down how we currently view the space and references the trend mentioned earlier in this report about supporting talented builders leaving later stage companies to pursue an entrepreneurial route.
Early-Stage takes slight dip
Q1 and Q2 showed early stage deal activity (Series A and B) stayed relatively resilient and held firm in line with historical funding performance (above $20B/quarter). However we saw the drag of the public markets and later stage markets finally take effect in Q3, with more pullback coming in Q4.
Q3 2022 saw a -33% pullback, and that continued in Q4 2022, which produced $11B across 446 deals, a -25% drop QoQ and -62% decline YoY. Q4 2021 was an all time high for early stage deal activity, however the message cannot be overlooked - the general market pullback due to an assortment of macroeconomic factors has firmly taken hold in early stage deal activity. We still see opportunity in the market and reason for optimism, but these occurrences are situation dependent where founders are solving urgent, burning problems.
Andres Dancausa, General Partner at TheVentureCity, leads our Europe-focused Series A investments out of Madrid. He has observed over the past quarter founders’ need to focus on delivering on their visions, providing concrete value for customers, and building sustainable business models based on metric-driven results. He opined further here:
Late-Stage continues to tumble
Late stage deal activity (Series C and later) continued on its downward trend, nearly being eclipsed by early stage deal volume. Q4 produced only $12.8B across 148 late stage deals, down -37% QoQ and -73% YoY.
Late stage deal activity has suffered the most compared to other stages of venture due to its proximity to the IPO markets (drawing upon similar LP investor bases) and investors’ lack of confidence to deploy capital due to the lack of exit activity recently. Q4 2022 produced only $5.2B in exit value from venture-backed startups, the lowest quarterly total in a decade.
Q4 also posted only $763M in acquisition value, the first time in a decade this number dropped below $1B. Globally, only 14 venture-backed companies went public in Q4 and 76 for all of 2022. Due to this low level of exit activity, later-stage investors are being incredibly cautious and waiting for more favorable market conditions where they believe new investments have higher probability of exiting in the near term.
Later stage founders are in the most precarious situations. They do hold the highest equity value inherently of all venture-backed startup founders, but are the most vulnerable to accept unfavorable acquisition terms or face liquidation.
Later stage founders must be incredibly careful to manage headcount, cash burn, and operational execution otherwise they may face a situation where their life’s work could be wiped out.
On the flip side, the late stage founders that make it through this period stand to benefit the most from capturing asymmetrical market share compared to when operating in more neutral fundraising environments.
Trend Spotlight: Intersection of Science and Technology
When science meets technology and timing, extraordinary things happen
Linking back to what we shared earlier in this Benchmark Report, according to Bill Gross often timing is the biggest driver of startup success. We think of timing as building the right solution for the right problem at the time when technology has advanced to the point where new value can be unlocked. We hone in on three sectors that are having their moment right now due to timing, and VC dollars are rushing to invest in these spaces for that reason. These include Generative AI, Mental Health, and ClimateTech.
Generative Alternative Intelligence
Alternative Intelligence (AI) is intelligence demonstrated by machines as opposed to humans; some examples of this type of intelligence include speech recognition, computer vision, and language translation. AI development dates back all the way to the early 1950’s, but has not, until recently, reached mainstream application due to limited computing power available.
However, due to breakthroughs in the space over the past decade which coincide with Moore’s Law (theory that computing power potential doubles every year), we have arrived at a juncture where AI has advanced to the point that it is significantly more impactful than humans.
Traditional AI for the past 20 years typically fell under the umbrella of “Analytical AI” - computers are more capable than humans at analyzing a data set and spitting out results. However, they were inferior at generating creative work - new work as opposed to understanding something that already exists. That shift is changing with the onset of Generative AI - creative work by machines that can come in the forms of art, coding, graphic design, architecture, gaming, law, sales, marketing, etc. This technological advancement has the capability to bring the marginal cost of creation to zero, thus generating massive labor productivity and economic value. This massive shift was propelled into the public eye by OpenAI; their significant breakthrough of ChatGPT opened the eyes of the public to what AI is capable of.
With the launch of ChatGPT in late 2022, the general public is getting its first taste of powerful Generative AI. Although far from perfect, the potential of the tool is undeniable to help workers become more productive with creative generation. Advancements in AI algorithms have led to the creation of tools like DALL·E 2, ChatGPT, and Stable Diffusion which have sparked some of the largest VC deals last year. The release of GPT-3 gave birth to AI content generators like Jasper ($125M Series A at a $1.5B valuation) and Copy.ai which have seen massive success, despite the crashing startup funding market. Besides written content, recent AI advancements have become the foundation of a unique intersection between art and technology. Companies like Midjourney and Stable Diffusion have made strong names for themselves in the AI-powered text-to-image landscape. As AI algorithms continue to improve by learning from user feedback, Generative AI is positioned to make waves in the world of technology and beyond.
We are heavily interested in the Generative AI space and the pervasive applications it will have on society. Although there is plenty of noise in the space, clearly there will be many winners for the founders that use the tech to solve real problems where AI contributes real productivity value. This market map helps us to better organize and understand the space.
Mental Health Technology
The COVID-19 pandemic has increased stress and uncertainty to individuals all around the world, leading to an increase in reported mental health issues. According to the World Health Organization (WHO), the pandemic caused a 25% increase in anxiety and depression worldwide.
With mental health issues on the rise, founders are taking notice and solutions are emerging. Combine the rise of global mental health issues with significant advancements in science, startups are using technology to productize and distribute treatments at scale.
Startups are now developing innovative technologies and therapies to provide mental health care to those in need. Startups are utilizing virtual reality, machine learning, sound therapy, and hypnosis to improve the availability and accessibility of mental health care. We believe deeply in the responsibility of tech to solve some of humanity’s biggest problems, and few startups better exemplify that call to action than Reveri.
We recently invested in Reveri, an app that enables self-hypnosis therapy. Reveri is backed by four decades of research from David Spiegel, the leading researcher out of Stanford on hypnosis’ ability to alleviate mental health issues. Reveri allows users to treat a variety of conditions including anxiety, addiction, chronic pain, and many more! Below you can hear more from Ariel Poler, Reveri’s founder, about how hypnosis and other scientific methods are effectively helping patients self-treat themselves through technology.
Scientists have long been saying the effects of climate change, based on the rate of pollution emitted worldwide, will soon become irreversible. This past year founders and early stage investors took that to heart. In 2022, early stage activity in ClimateTech accelerated 61% and deal count grew 40%!
This growth coincides with recent advancements in sustainability technology that look promising. Companies like Ampcera are building high performance solid-state lithium-ion car batteries, which can provide higher energy storage, thermal stability (less risk for fires), and faster charging.
In addition, new materials such as lithium-metal anodes can increase energy density of batteries, which allows for longer driving ranges. Sustainable material companies like Algensis are developing new bioplastics which create less carbon dioxide when recycling.
With the irreversible effects of climate change fast approaching, the urgency for a sustainable future continues to grow. With this burning problem comes founders running to solve key climate-related problems, followed closely by investors who hope to capitalize on this growing opportunity.
Q4 and all of 2022 brought many challenges to the startup ecosystem. The main trend we saw was VC dollars leaving the ecosystem and investors reverting to a “wait and see” attitude. While investors “wait and saw”, founders had to adapt and focus their efforts on survivorship as opposed to growth. Few geographies and sectors were left unimpacted, and we will see many down rounds, M&A, and liquidations as a result. However, we have much reason for optimism moving forward.
We see inflation metrics easing and the Federal Reserve is changing its tone to make rate hikes less severe. This long-term change in monetary policy will have pervasive effects across capital allocators - as debt becomes less expensive investors will again rotate back into risk assets. We may not return back to the normal we are accustomed to of abundant cheap capital, but of a new normal where exceptional returns are harder to come by according to Howard Marks of Oaktree Capital Management.
As capital eventually returns to the VC ecosystem, investors will allocate it to tech that will change the world as we know it. Sectors like Generative AI, Mental Health, and ClimateTech represent just a fraction of the opportunity in the market. Due to this market pullback, only the founders that are solving real problems will survive due to their customers’ burning need for their products. The tagline for our TheVentureCity 2023 Annual Summit in Miami encapsulates this sentiment well: Listen to the Music. Not the Noise. We look forward to backing these founders as they change the world for the better.