In Q3'22, global VC activity dropped to its lowest numbers in over two years, with just $87 billion in funding. While not all of the venture capital news is negative, there are a handful of obstacles the VC community faces in 2023.
Here are a few of the biggest challenges facing the venture capital industry today:
- Geopolitical Tensions
Issues like the energy crisis, economic sanctions and unstable political situations have made some investors nervous while displacing others and contributing to the overall uncertainty of the global venture capital market.
Experts note that it can be difficult to directly link investment strategies and stock market performance to geopolitical concerns because there are so many moving parts to consider. However, it is possible to quantify the effects of certain situations, such as the 2024 Taiwanese presidential election, and demonstrate how they affect venture capital. A recent research study showed that even a news-based measure of geopolitical risk factors could be combined with well-known industry risk factors to determine negative effects on investment.
For example, businesses are reducing operations in certain markets like China, and the flow of investments is restricting, too. This is because venture capital is a game of long-term strategy rather than short-term results. VCs must think far beyond the immediate because the average exit can take anywhere from 6–9 years or more. Because of this, everyone is in a kind of holding pattern, and nobody wants to take the risk of acting.
This means it’s critical to look for other avenues of financial resources and explore other manufacturing means. In one case, a startup launched a huge Black Friday sale for its yet-to-be-manufactured product and was then able to use that money to produce its stock.
Some data shows that this affects not only the stock market but also the flow of global capital. Emerging markets often get less funding than developed ones.
- Economic Recession
When we were in a bull market, the number of VC funds exploded. Pitchbook estimates that 1,100 new funds have been created since 2018. However, as we enter a bear market and collective belts are tightening, firms like Sequoia Capital urge entrepreneurs to prepare for hard times and not expect a “swift V-shaped recovery as we saw at the outset of the pandemic.” Y Combinator says to strive for a “Default Alive” state to develop without financial support.
Economic downturns bring down valuations, IPOs and round sizes, and investors spend much more time researching deals before making any funding commitments.
Matthew Kennedy, senior IPO market strategist for Renaissance Capital, recently told CNBC, “[Startups] will need capital and face the prospect of a down-round due to the valuation reset. Companies also face slowing growth as [sales and marketing] budgets get tighter…Companies without a viable path to profitability may be sold or shut down.”
The state of the global economy is putting the brakes on what has otherwise been a white-hot streak of funding over the past two years. Now, only the startups that can stay lean and pull themselves up by the proverbial bootstraps are the ones that will thrive in the long run.
- Equal Representation
A report by BLCK VC noted that 54% of Black VC partners were only able to achieve that status by founding their own firms. These funds are 46% smaller than the industry average.
BLCK VC co-chair Frederik Groce says, “There’s an incredible need to ensure there are resources in place so [minorities] don’t churn out of the community…It’s time to broaden and give others access to what we are doing. It takes a village if we really want to see things start to shift [in venture capital].”
In addition, author Scott Galloway’s research shows that, in 2021, 58% of VCs were still white men, with Asian men making up 20%. White, Asian and Black women collectively account for only 18%, while Black and Latinx men are only 3%. In Galloway’s data, Latinx women are not represented at all.
The cofounder of BLCK VC, Sydney Sykes, offers an opinion on why this is:
“VC, more than a lot of industries, is very network driven in the way that they hire. The network started 40 or 50 years ago with a lot of white men who had the wealth at the time to invest in companies. As VC has grown, a lot of the people who started it hired people they knew; there wasn’t an effort to recruit from outside of their network.”
Equality goes beyond nationality, too. It encompasses gender disparities, such as the fact that all-female teams in the U.S. received just 1.9% of the total $238.3B global VC investments. It also means equal representation across regions. Currently, North America holds 51% of venture capital, while Europe only claims 13%, the Middle East accounts for just over 4% and Africa accounts for less than 2%.
However, the Venture Capital and Social Equity report released by Morgan Stanley in December 2022 shows that VCs recognize this challenge and are increasing their focus on encouraging diversity and closing funding disparities.
What Does the Future Hold for the VC Community?
While it’s true that the problems currently plaguing the venture capital community are serious, the good news is that most experts are cautiously optimistic about the future of VC, especially as the market continues its slow post-pandemic recovery.
As the community continues to recover, it’s essential to keep these challenges in the spotlight so that VCs can move toward the future with open eyes and a mindset toward finding new, unique solutions to these problems, improving the health of the global community and fostering even greater innovations for the world.