Valuations fall as nontraditional investors pull back

Participation in venture deals by nontraditional investors, who have had an outsized impact on VC valuation trends over the past decade, steadily declined throughout last year in response to volatile macroeconomic factors and a less attractive risk/return profile due to the sluggish pace of exits.

That’s one of the leading takeaways from PitchBook’s newly released US VC Valuations Report for 2022. Nontraditional investors such as hedge funds, corporations and PE firms are especially vital for the top of the venture market, where capital needed by late-stage companies is often more than what VCs alone can support.

As many of these investors have abandoned the venture market, valuations have suffered, though not equally across all stages. The median pre-money valuation for late-stage deals fell 13 percent to $100 million in 2022, while the median valuation for deals in PitchBook’s new venture-growth category dropped 22 percent to $600 million. By contrast, the median pre-money valuation for late-stage deals with no NTI participation rose 11 percent from 2021 to $40 million last year.

“For a lot of corporates, [corporate VC funds] and crossovers, it’s a tough pill to swallow locking up a bunch of capital in a company that’s not going to be able to exit given what’s going on in the [public] market,” PitchBook analyst Vincent Harrison told Venture Capital Journal. “And mind you, these businesses are putting out fires in [their] public portfolios as well, especially if they’re a crossover investor.”

In December, PitchBook carved a new category out of late-stage venture capital, calling it the venture growth stage. The new stage is defined as those companies that have raised at least six financing rounds over their seven-year or longer existence. The decision to split late-stage into two categories arose after PitchBook saw a widening disparity between the top-decile US late-stage valuation, which peaked at $1.4 billion in 2021, and the bottom-decile valuation, which reached $15 million that year, as explained in an analyst note. The valuation disparity reflects a wide range of investment risk profiles for investors, PitchBook noted.

While nontraditional investor participation in late-stage deals is dramatically lower since 2021, it does not seem to have declined by nearly as much in early-stage deals. In fact, it may have increased. Early-stage valuations for deals that included NTIs continued to climb last year, surpassing those in 2021 by about 27 percent, and outpacing a nearly 17 percent increase in valuations for deals without nontraditional investors.

With exits likely to remain frozen for the near term, which will lock up expected returns for investors, PitchBook predicts that valuations will continue to decline for late-stage and venture-growth deals seeking nontraditional investor participation.

Even so, innovation and the investment returns it can generate remain a draw for many nontraditional investors. “A lot of these crossover investors still find venture capital very attractive and perhaps for some of them that are doing better in their public market portfolios, they’re able to remain involved,” Harrison noted.

He added that NTIs with a greater appetite for risk may choose to be opportunistic in the current environment. That’s more likely for investors like corporate VCs that see themselves in a stronger position than competitors who may “have to sit on the sidelines,” Harrison said.

Valuations for earlier stage deals have suffered far less than those for late-stage deals, mostly because they are viewed as more insulated from public market pressures. The median value of seed-stage deals continued to rise, up about 17 percent to $2.7 million in 2022 from $2.3 million in 2021 and 29 percent higher than in 2020, according to PitchBook.

Top- and bottom-quartile deal values were also higher than the prior year. While deal count, at 4,674, was down nearly 12 percent from 5,300 in 2021, it was 17 percent higher than in 2020.

Although pre-money valuations for early-stage deals trended higher (a 19 percent hike for the median) from 2021, the median valuation dropped about 33 percent from $60 million in the first quarter to $40 million in the fourth quarter. Despite the decline, quarterly pre-money valuations in 2022 narrowly beat their counterparts for 2021 and were nearly twice as high as 2020 levels, PitchBook said.

Early-stage start-ups were shielded from market headwinds in 2022 more than late-stage companies, which were hit harder by capital constraints and blocked paths to exit. “Early-stage companies benefited from record levels of dry powder – especially capital raised during 2021’s pandemic-fueled market exuberance – as well as investors adjusting their investment strategy by moving upstream, where companies in nascent stages of development are further insulated from public market volatility,” PitchBook noted.

A weakening early-stage market throughout last year, however, was reflected in a decline in the median valuation step-up from 3.35x in the first quarter to 1.95x in the fourth quarter. It was the lowest step-up since the third quarter of 2020 and below the five-year average of 2.29x.

“Should the venture exit market remain frozen, and the pressure on dealmaking continue shifting upstream, we expect to see a prolonged, faltering quarterly trend in the months ahead,” PitchBook predicted.

There was also less value created between equity rounds for late-stage startups. Median velocity of value creation – defined as the annual increase in pre-money valuation between two financing rounds measured in US dollars – dropped by 36 percent to roughly $22.2 million in 2022. The median step-up multiple for late-stage start-ups in the fourth quarter sank to a 10-quarter low of 1.60x, “further illustrating the dampening effect lower capital supplies had on the late-stage venture ecosystem,” PitchBook noted.

The velocity of value creation for early-stage start-ups also fell, but not as sharply. It declined 15 percent to $37.3 million in 2022.

Shifting deal terms

The top-decile valuation for late-stage fell to an eight-quarter low of $470 million. Lower valuations stir investors to seek better terms to de-risk their investments, and by the end of 2022 PitchBook said it was seeing higher equity stakes taken in rounds.

As the venture market has become more investor-friendly, “we’re seeing different deal terms and downside protections pick up, whether that’s cumulative dividends or liquidation participation,” Harrison noted. There’s a lot of uptick there and that’s at all stages of venture capital where investors are taking back more leverage. Our expectation is that the market will become increasingly investor-friendly in 2023.”

For venture growth-stage companies, the annual median pre-money valuation fell 17 percent to $290 million. It would have declined further except for heavy support by Q1 and Q2 figures, which helped offset a plunge in Q4 to $132 million, the lowest since Q1 2020.

PitchBook said it expects economic headwinds and frozen paths to liquidity to continue to push valuation declines and increased down rounds for start-ups at the top of the venture market, barring a sudden turnaround in public markets and investor sentiment.

Vertical disparities

There were also some notable differences in how valuations fared across verticals last year. At the venture growth stage, biotech and pharma valuations shined in contrast to those in fintech, enterprise tech and consumer tech. The median pre-money valuation for biotech and pharma spiked 87 percent, while falling by 22.7 percent and 45.7 percent in enterprise and consumer, respectively. The median valuation for fintech was 4 percent lower.

Valuation changes for all other stages were more closely aligned from flat to marginally higher across all verticals, except biotech and pharma, where late-stage dropped by 21 percent.