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Roula Khalaf, editor-in-chief of the FT, selects her favorite stories in this weekly newsletter.
Two years ago, US venture capital giant Sequoia issued a stark warning to tech start-ups. Recovery from the market downturn would be slow. The type of aid that supported the economy during the pandemic will not happen again and cheap financing is no longer an option. The grim prognosis was correct. The U.S. startup sector is still grappling with the biggest funding problem since the dot-com crash.
The pile of unallocated capital, aka dry powder, is vast. Data from Silicon Valley Bank puts the total at $277 billion, while the National Venture Capital Association estimates it to be closer to $312 billion. Regardless, this is an all-time high and more than double the amount available in the dot-com bubble – adjusted for inflation. Prudence in allocating funds means that the dry powder to investment ratio is lower.
The low interest rates that pumped nearly $27 billion into crypto startups in 2022 and turned robot pizza startup Zume into a $2 billion company are gone. In the first quarter of 2024, venture capital financing deals in the United States fell to their lowest level since 2017, according to PitchBook. With prospects for rate cuts dwindling this year, this trend is likely to continue.
In the public markets, the valuations of the largest technology companies have already rebounded. The high multiples they trade at have pushed the S&P 500 Shiller’s broader price-to-earnings ratio, aka the cyclically adjusted price-to-earnings ratio (CAPE), from less than 30 times at the end of 2022 to 34 times.
However, the start-up slowdown continues. Startups blame an inhospitable IPO market and regulators who limit mergers and acquisitions. Without an exit, it becomes harder to persuade investors to part with their money. It’s taking longer for venture capital firms to close new funds. More than a third closed below their target last year, according to Silicon Valley Bank data.
New venture capital firms are facing the toughest times. At the end of last year, the United States had 3,417 venture capital firms, according to the NVCA. This represents an increase from 1,000 in 2008. A funding squeeze could result in a reduction.
There are good reasons for investors to be wary of where their money is allocated. The start-up sector must take responsibility for never fully integrating the downturn that has hit the public markets. There have been bankruptcies, notably Zume, but many start-ups have retained their cash and chosen not to raise funds at lower valuations. When stock prices fell, their valuations seemingly remained the same.
Without a reality check, VC powder will remain dry.