The thought of a potential global recession might have you cutting back on spending. Startup investors are doing it, too. Venture capital investors are pumping the brakes on aggressive funding of startups, spooked by an uncertain economic picture, plunging tech industry stock prices and growing recession fears.
In the final quarter of 2022, investments in North American startups fell 63% compared to the same period a year earlier, according to a new Crunchbase report. In other words, If you're among the large number of Americans hoping to quit your job and pursue a side hustle full-time, you may want to wait a while. "A year ago, we were not anticipating we would be where we are today," Jeff Grabow, a venture capital leader at global accounting firm Ernst & Young, tells CNBC Make It.
"There [were] none of the storm clouds on the horizon that have come in through geopolitical instability, inflation being more endemic, and having rising interest rates and recessionary fears." Another prominent factor behind the steep drop: stock market turmoil causing tech startup valuations to plummet, freezing the market for IPOs and resulting in widespread tech layoffs, Crunchbase suggested in a blog post. It's unsurprising to see such market volatility cause a dip in late-stage startup investing. Yet early-stage startups saw a reduced appetite from investors too, Crunchbase noted.
Notably, 2021 set a record high in startup investments, with VCs spending $329.1 billion, according to Crunchbase data — so the significant drop in 2022 still represents the second-highest amount of annual funding since the company started tracking these stats. But the decline represents more than just a temporary setback, Grabow says: Rather, it's a market reset that could lead to an even "softer" market for startup investments in 2023. "This business, it's a marathon," he says.
"You can't sprint to it, and we've been sprinting for a while. So now it's time to get back on cadence." Many investors expected inflation to be under control sooner, along with a slight rise in interest rates, Grabow notes. Instead, the Federal Reserve raised interest rates to their highest levels in 15 years, which has helped cool inflation while temporarily hurting tech stocks.
As a result, VCs have pulled back significantly on the aggressive funding trends of 2021, Grabow says. Suddenly, instead of VCs competing over who gets to fund a hot new startup, that startup could struggle to convince investors to open up their purse strings, he adds. Funding won't disappear completely in 2023: Over the past two decades, a long string of successful companies launched out of down periods, giving VCs a track record of startups still worth investments.
But if you don't already have enough capital to survive through the next two years — roughly the amount of time many VCs expect this down period to last, Grabow says — don't count on getting a significant amount of external funding for your idea anytime soon. "The hope is in two years, we'll be through the uncertainty ... and you can come out on the other side and catch an uptick," Grabow says.
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