The amount of venture capital flowing into startups dipped below $40 billion last month, according to a Crunchbase report. That’s the lowest monthly investment rate in more than a year and well below the $70 billion invested in November, according to Crunchbase data.
The slowdown in investing reflects broader concerns with the economy. But it’s not the most interesting data point in the Crunchbase analysis.
Crunchbase reports that seed stage funding hit $3.1 billion last month. And that in 2021, the average monthly investment in seed stage companies was $2.8 billion.
So why is seed stage funding up while growth stage and later-stage funding is down? There are three reasons, really.
- Valuations
- Time horizons
- History
Let’s take them one at a time.
Valuations
Thanks to the billions of dollars rolling around the private markets for the last decade, valuations for later-stage companies have been ridiculously high. Revenue, profitability and user growth didn’t match the valuations that startups were (successfully!!) raising at. There was really no justification for it. That’s changing now.
Share prices for later-stage companies are plummeting. They’ve dropped anywhere from 22% to 44% in recent months, according to EquityZen. Instacart cut its valuation by nearly 40% earlier this year (I talked about it on the First Stage Investor Startup Insider podcast in April).
Seed stage companies have much more reasonable valuations right now. The valuations are tracking more closely with how much traction a startup has or a company’s potential for disruption. This gives startups plenty of time and room to grow organically.
Time Horizons
The public markets are rough right now. The Nasdaq is down about 25% on the year as of this writing. The Dow is down 11%. And it doesn’t look like there’s any relief in sight. The Fed doesn’t have inflation under control (and probably won’t until at least the end of the year). Gas prices are soaring. Supply chain disruptions are still plaguing the economy. Tech companies are laying off workers. The housing market is fundamentally broken. Any company that goes public now is facing the very real possibility (or likelihood) that its share prices will drop right away. Investing in later-stage companies that are close to going public — or need to go public soon — just doesn’t make any sense.
But seed stage companies won’t go public for several years. By that time, we’ll be in completely different — and hopefully better — economic times. And that should lead to higher returns.
History
Some of the best companies we’ve ever seen were created during tough economic times. Airbnb (2008), Uber (2009), Venmo (2009), Slack (2009) and Pinterest (2010) all emerged from the ashes of the 2008 Great Recession. Going further back in history, Microsoft was launched in 1975 and Electronic Arts in 1982. Top investors know this history. They don’t want to miss out on the next amazing company. So they’re willing to invest more at the seed stage right now.
Ultimately, all of this boils down to the most basic rule in investing: buy low, sell high. Right now, the valuations for later-stage companies are too high relative to where the public markets are. But seed stage prices are much lower. That significantly increases the upside and makes taking on some added risk worth it.