Venture Capital Benchmark Q1 2023
US, Europe, AND Latin America
Time to build
It is often darkest before the dawn. As you will read, startup fundraising fell across the board, few geographies and stages were spared. We can attribute this to many factors: continued rising interest rates due to concern about inflation, sluggish exit value at late-stage VC which impacts the entire ecosystem’s ability to fundraise, trepidation about the war in Ukraine causing further shockwaves across commodities markets, and investor flight to safety and interest-bearing assets. Founders across the board, particularly at late stage, have struggled mightily to raise capital as the bar for attracting VC dollars has raised considerably. Founders have shifted all attention to lowering burn rate, focusing on only the highest value activities to scale, and retaining customers at all costs. From a high level perspective, it seems like times are tough in the startup ecosystem.
We won’t sugarcoat it for you: financial markets could be in a better place. However, for founders just starting out or in the early stages of building, there has rarely been a better time to build.
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.
Advancements in tech allow founders to build at different size and scale
For the founders and investors that have witnessed multiple market cycles, they know that massive opportunities exist today, especially given the technical advancements available at founders’ fingertips. Many massive, generational companies were founded during recessions or massive market displocations. Chamath Palihapitiya from Social Capital comments on the phenomena in relation to high interest rates, a common contributor to recessionary environments when equity markets recede. Ultimately, he concludes that technology startup success is most likely to occur when companies exploit massive technology innovation during periods of higher than average interest rates. The former part of this tech startup equation may come in the form of leap forwards in alternative intelligence (AI) and reduction in cost of computing power.
AI is finally realizing its potential as a horizontal tech enabler to disrupt virtually every industry and make products better. Founders are rushing to incorporate AI into their value propositions while VCs debate where in the AI value chain they should invest, and which portions are most likely to win. The pace of innovation in the space is frightening for many, especially with the onset of ChatGPT by OpenAI and the rapid advancements of their computing models that huge enterprises are now adopting. This pace is so fast that many well-regarded AI experts are calling for a 6-month pause on experiments in AI beyond GPT-4 so regulation and the public can catch up and prepare for the progress (or regress) that is upon our doorstep. However, innovation is hardly containable, best exemplified with the recent launch of Auto-GPT which can autonomously run AI prompts to achieve an end goal with little to no human intervention. Combine that with the marginal cost of energy and computing going to zero, founders have unbelievable technological resources available to them to build incredible products.
Rodrigo Teijeiro, Founder & CEO of RecargaPay, has needed to pivot, restrategize, build new products, understand new customer preferences, and survive economic and political fluctuations to build his conglomerate company in Brazil. Through it all, he has learned several lessons, but none as powerful as the need to find the light at the end of the tunnel no matter what comes his way:
The bleeding starts to stabilize
Q1 2023 produced $56.6B in deal volume across 4,804 deals spanning all funding stages from companies hailing from the US, Europe, and Latin America. While this figure pales in comparison to the $100B+ quarters from 2021 and early 2022, it is consistent with performance we saw from prior years.
Juan de Antonio, Founder and CEO of Cabify, has witnessed several market cycles and started his now unicorn at the tail-end of the Great Recession. He reflects back on what it was like building over the past decade and what founders can expect moving forward:
No matter the economic environment, some core tenants of fundraising stay the same. Andrés Dancausa, General Partner at TheVentureCity, highlights three key strategies for founders to keep in mind, especially during recessions: build relationships early, focus on sustainable growth, and turn challenge into opportunity. You can read more here: How to get a VC to swipe right on your startup.
When investors consider investments or even an entire asset class (such as VC), they consider two types of risk: idiosyncratic risk (the risk specific to the investment itself) and systematic risk (the risk of the entire market or market segment). Even with long-term investment horizons, investors place different weightings on these types of risk based on their interpretations of how the world may evolve.
Over the past quarter, some general market trends and black swan events affected every startup, no matter their sector, geography or stage. Investors took those into account and their future effects when deploying capital.
Silicon Valley Bank’s collapse ripples across VC ecosystem
Over a matter of sheer days, we witnessed one of the most significant financial black swan events in our lifetimes. In the matter of hours, we witnessed the 2nd largest bank failure in US history due to a variety of factors, namely poor asset quality, customer concentration, but mostly poor communication that led to deteriorating consumer confidence. This culminated in all depositors running to the exit at the same time.
When the dust cleared and the FDIC finally stepped in to backstop all deposits, clients withdrew $42B from Silicon Valley Bank (SVB). When all was said and done, individuals and startups lost vast sums of capital, HSBC acquired the SVB UK branch, and First Citizens acquired the US entity. The bank that had quite literally financed the infancy and maturation of the startup ecosystem had evaporated.
What were the effects? For starters, some banks and fintechs profited exorbitantly and others suffered dramatically as a result of SVB’s collapse. Global Systemically Important Banks (G-SIBs) are viewed as safe destinations to park capital, and some of the largest banks on this list were overwhelmed with capital transfers as businesses sought safety in the name of the largest global banking institutions.
As the saying goes, the rich get richer: JPMorgan Chase, which already was the largest US bank by assets at the end of 2022 with $3.3T on its balance sheet, grew deposits as a result of SVB failing by $50B and won many of their customers. Not only did this help boost profits by 52% in Q1 2023, but enables JPMorgan to potentially woo these new startup and VC clients for future transactional business, namely M&A and IPO underwriting.
Smaller banks were not as lucky. Even sound banks from a liquidity perspective suffered withdrawals, while others that resembled SVB’s financial position saw massive setbacks. First Republic Bank saw depositors leaving at the rate SVB experienced and were only saved from a consortium of banks that backstopped its balance sheet with $30B of life-saving capital. First Republic reported deposits fell 40% in Q1, its stock plummeted -89% over a 12-day span, it is currently being sued by shareholders for concealing bank risks, and it is in the process of slashing up to a quarter of its workforce. Ultimately, the government seized First Republic to protect depositors and sold it to JPMorgan. Signature Bank shuttered completely and was sold to Flagstar Bank.
Fintechs such as Brex and Mercury, which have served startups for years, stood up FDIC-insured bank accounts quickly to help startups impacted by SVB make payroll and receive access to cash quickly. Because of their reputations and ability to move with speed, they, along with other fintechs, saw massive deposit inflows.
Monetary policy under the microscope
Taming inflation has been the primary focus of the Federal Reserve (Fed) since early 2022. Throughout COVID-19 (early 2020) the Fed maintained rates at 0.00% - 0.25% to incentivize borrowing and investment in the economy while increasing the money supply (40% of dollars in the money supply printed since 2022) to keep citizens afloat.
Experts in general agree there will be one more rate hike this year, but this is far from guaranteed as more bumps in the road could be ahead. Inflation has fallen since July 2022, but that has come at a cost as a federal funds rate of 4.75% - 5.00% changes how investors, businesses, and individuals behave.
This caused an eventual overheating of the economy to the tune of 9.1% peak monthly inflation in July 2022 (Fed target is 2%). The Fed was forced to aggressively hike the federal funds rate from March 2022 until now to combat this rise in inflation. This has been effective; inflation has dropped from its peak to 5% in March 2023.
In short, most VCs are in the “wait and see” mode. The cost of borrowing is more expensive, less capital is available to deploy in risk assets as interest-bearing assets are now more attractive, leaving VCs and startups exposed and unsure of where their next capital injections may come from. For this reason, all groups in the startup ecosystem are preaching austerity and are reluctant to act aggressively while they wait out the inflation storm.
Ecosystem member perspective
Brenda O’Connor Juanes, as SVP at UBS, has her finger on the pulse regarding how banking activity and large scale trends such as rising interest rates impact global asset classes. She foresees more bumpiness ahead, but tremendous opportunity for startup founders given large market dislocations:
Where are we now, and what can we expect going forward?
Startup world is coming back down to earth. Redpoint Ventures published a presentation showing how multiples have changed and how trends in the space are evolving:
Public software companies are now trading at 3.4x - 6.0x next twelve months revenue, compared to 7.4x - 27.0x at their relative high a few years ago.
Venture funding typically takes many quarters to bottom out (sector and stage vary). We are currently 5 quarters since an all-time high, meaning we may see more pain before a recovery.
Early stage valuations were quick to correct 25%+ once funding dollars left the market.
They saw outrageous private market premiums to the public market in 2022 (as high as 787%)! This gap has narrowed to 385%, which is a reversal but still a significant margin.
So what will happen next? Nobody knows, but we can make reasonable inferences based on what has happened historically and the Fed’s guidance for the rest of the year. We could certainly see more of the same: less dollars deployed into startups due to investors being overly cautious, leading to generally less business activity. However, less activity and trepidation spells opportunity for the bold who build. Long term we see this new environment rewarding business models that can grow sustainably through short sales cycles and cash conversion cycles.
Data Deep Dive
Investors turn to retention vs. growth
At TheVentureCity, data has always been at the core of how we operate. So much so, that we built a tool in house called the Growth Scanner to evaluate all of the metrics that make startups tick. We encourage any founder to poke around it and submit their data for investment consideration!
Fundraising by Geography
US finds its relative bottom
Despite continued negative noise from headlines, the US surprisingly bounced back from a relative low in Q4 and saw an uptick in funding activity. Q1 2023 produced $43.6B in funding volume across 3,003 deals, a 5% increase from Q4 2022.
This amounted to an average deal value of $14.5M/deal compared to $12.4M/deal from the quarter prior. While these figures are nowhere near the production of quarters a year ago, they do provide an important reminder: headlines and metrics do not always align. There hasn’t been much positive sentiment for founders to latch onto, but from a fundraising perspective not much has changed since Q3 2022.
Kobie Fuller, General Partner at Upfront Ventures, continues to be excited about new companies emerging and investing actively in enterprise software. Regardless of market conditions, he uses a simple framework to evaluate companies which has served him well, and which he plans to utilize for the next decade:
European funding slides, but consistent with global narrative
European fundraising levels reached $12.4B across 1,697 deals in Q1 2023, down -20% from Q4. Similar to the rest of the world, Europe’s fundraising levels were disappointing, but in line with pre-2021 volumes ($13.3B in Q4 2020).
Europe tells a similar story to the rest of the world, investors in general see headwinds ahead and are being more selective and cautious with their capital.
However, 2021 and early 2022 represented unprecedented capital deployment periods, and now we have returned to a state of more normal expectations.
Reshma Sohoni, Founding Partner at Seedcamp, has seen first-hand how European early-stage startups have been affected by investor pullback. Regardless, she is optimistic about the future of EMEA startup activity because of the quality of founders and ideas she encounters every day:
Maria Tellez, Partner at TheVentureCity and based in Madrid, shares much of the sentiment that Reshma commented on regarding fundraising activity. She also acknowledges how entrepreneurs are adjusting and where she has seen opportunity recently:
Latin America sees less activity as fundraising winter continues
Latin America unfortunately continues to be hit by investor pullback as market conditions continue to try and find their footing. We have been telling a similar story since Q2 2022:
When investors started preparing for the eventual pain of a market slowdown, they prioritized their own portfolio companies and investing in geographies close to home that they know well. A large amount of VC dollars are held outside the region, so this led to LatAm suffering some of the largest swings in investor capital deployment. Q1 saw $563M invested into Latin American startups, down -43% from Q4 2022 and -84% from $3.5B in Q1 2022. Despite this drop, we still see many opportunities and reasons to be excited in the region.
A defining quality of many successful VCs is being contrarian. When others zig, few zag. That is exactly what Patrick Arippol, Co-Founder & Managing Partner at Alexia Ventures, is doing by actively investing in Latin America. He sees tremendous opportunity in the region, and investors pulling out means his positioning becomes all the better:
Country Spotlight: Brazil
Brazil sees opportunities in the midst of difficult fundraising climate
Brazil was not immune to the drawdown within LatAm, considering it often leads the region in terms of fundraising activity.
Ricardo Sangion, Partner at TheVentureCity, sees opportunity for founders in Brazil at the intersection of fintech and ecommerce. He believes, regardless of the fundraising environment, there are areas where founders can capitalize on market tailwinds:
Women in VC
Female co-founded startup funding falls further
Female co-founded startups raised $6.7B across 701 deals in Q1 2023, down -14% from Q4 2022 and -57% YoY. Female founders have felt further pain compared to their male counterparts;
Not only do female co-founded teams only represent 18.5% of VC dollars raised in 2023 (2.1% for all female teams), but these teams have been hit harder by the market pullback.
When the total US VC market shrank -53% from its all-time high in Q4 2021, female co-founded companies saw a -59% pullback. Despite this market retreat, women in the startup ecosystem continue to support each other and we see more women-led funds emerging who are committed to supporting female founders.
Lily Lyman, General Partner at Underscore VC, sees network effects across the female founder community and is encouraged by the continued growth within the space. She also comments on how early stage investing is developing and which types of entrepreneurs are seeing success in this environment:
As a fund founded by two women, we have always found it a competitive advantage to back superior female founders. Since our founding in 2017, female co-founded teams have raised between 16.2% to 18.5% of total VC dollars. We are proud to say 35% of our portfolio is composed of female co-founded teams. Much more work needs to be done, and we aim to achieve gender parity within our portfolio. We will continue to back excellent female founded teams and push for a more diverse and inclusive startup ecosystem.
Portfolio Company Spotlight: Tiny Health
Tiny Health is redefining gut health for mothers and children
We were proud to back Cheryl Sew Hoy and lead her seed round after she successfully exited her last company to Walmart Labs. She is now building Tiny Health, the most comprehensive microbiome platform for child and prenatal health, correcting gut imbalances that can prevent chronic illnesses later in life.
Their first focus is on babies and pregnant mothers, given that 50% of children today experience at least one chronic condition such as eczema, allergies, asthma, diabetes, and others. The microbiome has a much higher predictive power than genetics in the manifestation of 13 most common diseases, leading to a larger market potential of $1.1T. Their patent pending microbiome health tests uses next generation sequencing and AI technology to generate precise recommendations on infant development for parents, adult gut, practitioners and research partners.
Tiny Health is raising its Series A and is open to speaking with seasoned investors in the consumer biotech space. Feel free to read more about the company in Techcrunch, VatorNews, Fortune, CNBC, Motherly, FemTech Insider, Neo.Life, Spectrum News 1, 23 Austin startups to watch in 2023, and "Best for pregnant people and their babies”.
Industry Spotlight: Fintech
Q1 proved tumultuous for the Fintech sector
Fintech has long been a darling for VCs; one of the most heavily invested sectors due to its application to other industries and consistent ability to mint massive exits. Investors poured a record $140.5B into the space in 2021 (average $35.1B/quarter), but that pace quickly slowed to $9.7B by Q4 2022 as investors saw the writing on the wall: profitable, sustainable business models needed to be established ahead of growth at all costs.
SVB’s collapse only exacerbated the problem; former US Treasury Secretary Larry Summers predicted a cleaning out of the fintech sector as regulation tightens. Q1 2023 saw $15B invested globally into fintech startups. However, when one strips out the $6.5B mega-round from Stripe (43% of the entire quarter’s funding volume), the sector was down 12% from Q4 2022.
Average fintech quarterly exit volume in 2021 was $145B (larger than the massive sums being deployed in the space), $118.5B of which was within the IPO markets (82%). This number has slumped to $7B in Q1 2023, of which $3B was through IPOs or SPACs.
Fintech overall is seeing a massive mean regression as investors temper their expectations and be more judicious in how they evaluate the sector, especially at later stages. In 2021, more than 41 fintech unicorns on average were emerging per quarter. That figure was 7 in Q4 2022 and just 1 in Q1 2023.
Exit opportunities within fintech have slowed dramatically, which has affected all stages of VC investing. Since exit activity and investing activity have slowed, investors are adjusting the premiums they allocate to fintechs. Q1 2021 saw fintech companies in the SEG Index trading at median EV/Revenue multiples of 19x, now that number hovers at 5.4x as of Q4 2022. The message is clear, fintech as a sector has cooled off.
Our Investment Manager Oliver Henry took a deep dive into embedded finance earlier this quarter as a key vertical of focus for us. We won’t opine further upon what we already wrote, but we will double down on the idea that embedded finance will become a core part of all of our software product experiences, particularly in the B2B space. Just some applications we have seen recently include:
Embedded full-service lending platform to facilitate better B2B large-scale purchasing experiences.
SaaS platform for Latin American SMEs and bodegas with embedded payments incorporated into the process flow.
Personal loan reimagination for all types of applications within a variety of product experiences, which continue to get more and more niche, thus requiring more sophisticated and data-driven underwriting.
Better insurance underwriting for underserved population segments in emerging markets and facilitating better policy payment experiences.
The opportunities and applications are nearly endless. Wherever there lies a software experience with a clunky payment portion of the value chain or an opportunity to upsell, embedded finance has the opportunity to add value.
Building at the best time
Over-exuberance fueled much of the pullback within fintech, but we still get excited about the tremendous opportunity for tech to disrupt financial services. We are confident in a number of trends and theses and are actively searching for companies that align with one or more of them:
Fintechs can encapsulate a variety of business models with varying expectations for key KPIs: net retention rate, revenue growth, gross margin, and operating margin. However, a good guideline for blending them together is the “Rule of 200”: between these four key drivers fintechs should achieve above 200% (this can be compared to the “Rule of 40” for software companies).
Emerging markets such as Latin America still present extraordinary opportunities for fintech deployment. In LatAm, the combination of internet and smartphone penetration, a large population coming online, and under penetration of credit leaves a massive void for fintechs who focus on customer service and building slick product offerings.
The Rule of 200 contributes to our thesis that B2B embedded finance will be a fast-growing and lucrative sector going forward: net revenue retention for B2B companies is historically higher than for B2C (125% vs 94% on average). Also, embedded product offerings are notoriously difficult to strip out once implemented. We have seen most winners and growth in fintech come from the consumer space, which tells us that there is tremendous opportunity for fintech B2B models.
Fundraising by Stage
Seed slides in line with overall market
Seed deals produced $4.5B in funding volume across 1,203 deals. This represented a slight -16% drop QoQ, which wasn’t a huge drop relative to other verticals and geographies.
Early stage investors are cautiously optimistic at the current juncture: seed companies typically are more insulated from overall market conditions and have more control over their destiny in the short term. Certainly less deals are getting done at later stages, but seed funding levels remain healthy in context of historical performance (Q1 2023 falls in line with levels seen in the later parts of 2020).
Arjun Lall, Co-Founder of Rocket, sees a similar dynamic as we do currently in early stage investing. There is a stark contrast between the decline of fundraising but incredible advancements in technology. He opines further on what is making him excited:
Geri Kirilova, Managing Partner at Laconia Capital, maintains a positive outlook on investing at the earliest startup stages. Due to the long time horizon associated with this style of investing, Geri blocks out the noise and focuses primarily on exciting developments within sectors that are primed for disruption:
Early stage deals slide further
Similar to the rest of the market, early stage deal making was not insulated from market turmoil. Early stage fundraising volume fell to $8.8B across 364 deals, shrinking -28% QoQ.
We view this decline as a continuation of what we’ve seen over the past 5 quarters - investor pullback starting from the public markets has slowly impacted fundraising activity at earlier stages. We are now seeing the fullest extent of this pullback in effect: what took the public markets 3 quarters to feel (Q1 - Q3 2022) is taking place at early stage VC, but delayed. We can expect more of the same until macro conditions improve and investors start to reenter the market.
Rodrigo Teijeiro, Founder & CEO of RecargaPay, commented earlier that certainly market conditions play a role in general startup success. However, he offers advice as a founder who has faced down failure more than once before and survived and thrived:
Late-Stage continues to lag as IPO and M&A markets fail to provide liquidity
The massive funding quarters from late-stage deal activity continue to dwindle as liquidity opportunities evaporate, causing late-stage companies to operate longer and investors to grow more cautious with the fear their capital will not be quickly redeemed by corporate M&A or public market investors.
As mega funds dwindle, so do unicorns
Much of what propelled the fervent deal activity of 2022 were mega late-stage rounds. To fuel massive rounds, massive funds must be raised by a base of LPs eager to enter the late-stage VC space.
Where does that leave current late-stage companies? In the search for profitability to weather the storm. Considering 18 unicorns were minted in Q1 2023 (compared to 153 from Q1 2022) and US exit value (as a proxy of the overall market) in Q1 2023 was 2.2% of the all-time high set in Q2 2021, less options are available for late-stage founders. For founders at this stage, business model sustainability and austerity are paramount to achieving short and long-term success.
Lily Lyman, GP Underscore VC, sees more trouble ahead of late stage founders, where the ones with sustainable business models will continue to succeed, but the ones propped up solely by VC dollars will feel further pain. Less capital resources mean these founders will be left to fend for themselves, and their only savior will be profitability and product market fit.
Q1 2023 was a mixed bag for the startup ecosystem. From a high level, optics certainly don’t look ideal. Funding and fundraising are down across the board, investors and startups alike are licking their wounds after deploying and raising during an overheated market, and every business is in search for sustainable, profitable business models with retention at the core of the product user experience. If you ask the Average Joe investor, they would say times are tough and there isn’t much reason for optimism.
However, we pride ourselves on being far from average. We see tremendous opportunity in this market for the founders who are experienced, build with austerity in mind, and take advantage of one in a generation technological advancements. There are certainly challenges ahead, but history has shown us that now represents one of the best times to be a VC with dry powder. We are excited to back these founders and continue to find the next crop of companies that will change the world.