More VC Headwinds Likely
Over the past decade, venture capital (VC) has emerged as a critical source of funding for space startups, with total investment surging more than tenfold, from $0.3B in 2014 to $3.2B in 2022 (note: excludes megaconstellation funding). Similarly, the number of funded space startups grew from <10 in 2011 to well over 400 by last year — boom time for space startups.
Unfortunately, a higher rate environment has changed that dynamic. Triggered in part by the Fed’s battle with inflation, the 2022-2023 Fed funds target rate has ratcheted from ~0% to >5.25%, and the FOMC has reversed to “quantitative tightening,” these shifts in turn driving a sea-change in the investment climate.
A key so-called “risk-free” rate benchmark, the 10-year U.S. treasury note, has seen its effective yield increase from 0.9% at the start of 2021 to ~4.7% today. With investors now able to fetch 5% returns on a risk-free basis, the market environment has shifted considerably:
1. A flight of investors has occurred from higher-risk investments (a la 2021) to “safer” yield investments.
2. Companies that don’t generate returns (i.e., cash flow/profits) for years to come – which includes most venture-stage companies – are worth significantly less (a higher discount rate applies).
3. As a consequence of these factors, it costs much more for companies to raise equity or to borrow.
These effects have tanked not only the public equities but also private markets – particularly venture. For the VC industry, exits have become more difficult (i.e., closed IPO market), while VC returns and fundraising have fallen to a decadal low. While there are some early indications that the industry may have hit bottom, there is at least one indicator that suggests the industry has more medicine to take. More specifically, the ratio of down-round financings. In a “healthy” venture capital market environment, down rounds, where venture-stage companies raise their next financing round at a lower valuation than their prior financing round, are pretty rare
According to the latest data from Pitchbook, less than ~11% of venture-funded companies were forced to price a “down round” year-to-date, which represents a two-year high but just a fraction of damage experienced in previous financial crises, including the 2008 housing crisis (~35%) and the dot-com bubble (~60%). While not a perfect proxy, space SPACs are down 60-90% since their public debut.
Compounding the cash flow/liquidity challenges already faced by some venture and de-SPAC companies, the growing threat of a downround will take the capex foot off the gas for many capital-intensive companies, including early-stage constellation operators. It would be hard to imagine that many private companies that priced a round during the 2021-2022 hype cycle aren’t also due for a haircut.
SOURCE: https://pitchbook.com/news/articles/down-rounds-venture-fundraising-VC-deals-recession