Venture Capital Landscape Amid Global Turbulence: Seed-stage Valuation Trends and Impacts

DALL·E-2023-05-11-10.54.37-asymmetrical-abstract

The global macroeconomic turbulence initiated more than a year ago has significantly disrupted the venture capital (VC) landscape. Late-stage startups were the earliest to perceive this impact, with the repercussions permeating down to lower stages as 2022 progressed.

As of 2023, such uncertainties have eventually diffused into the seed stage for a subset of companies.

Numerous seed-stage investors have talked about the noticeable reduction in seed deal solicitations, accompanied by a softening in valuations. However, Q1 data from PitchBook and Carta present a nuanced interpretation: Although Q1 was the most sluggish quarter for seed deals in the past 10 quarters, the median and average deal sizes, along with median pre-money valuations, experienced a hike compared to Q4 of 2022.

Nevertheless, a challenge arises when monitoring seed-stage deals, predominantly due to the incomplete data available. The data often captures only priced rounds and fails to account for Simple Agreements for Future Equity (SAFEs), which constitute a significant portion, if not the majority, of early-stage deals, thereby yielding an incomplete representation of the market landscape.

Loren Straub, a General Partner at Bowery Capital, a firm with a software-centric investment focus, shared that she’s observing a decrease in high-quality deal flow and a consequential shift in valuations since the latter half of 2022.

She noted that the bulk of the deals Bowery has evaluated or closed this year involved companies aiming to raise funds between $2 million and $3 million, often at a pre-money valuation lower than $10 million. For comparison, the median pre-money valuation as per Carta and PitchBook was approximately $13 million.

Kirby Winfield, the singular General Partner behind Ascend.VC, an investment firm dedicated to backing pre-seed AI and machine learning startups based in the Pacific Northwest, has observed a substantial 25% to 30% drop in valuations in the pre-seed deals crossing his desk, which might signal further softening in seed deals.

However, these deflated valuations are not universal. While outliers like SpaceX continue to augment their valuation despite turbulent late-stage markets, it doesn’t seem to be a case of exceptional deals distorting the data.

Deals are still being closed at these heightened valuations, through both priced rounds that are included in the data and other mechanisms. One notable source of such deals is Y Combinator. While the demo day is slated for April, several companies raise rounds in Q1, intending to augment their capital at the Q2 presentation.

Artificial Intelligence (AI) companies, in particular, should not be overlooked as they are likely contributing to the inflated numbers. AI, the latest trigger for Fear Of Missing Out (FOMO), appears to be making investors disregard the lessons learned from their recent overpriced investments.

During this year, several AI companies have secured substantial seed rounds. For instance, Product Science raised a $19 million seed round to enhance the speed of mobile applications using AI, and Fixie raised $12 million to automate large language models using AI. Furthermore, non-AI startups like Binske, a cannabis startup, Descope, an app authentication startup, and Carbonplace, a carbon credit transaction network, raised $80 million, $53 million, and $45 million, respectively.

As a result of these disparities, seed-stage investors like Straub face challenges in assisting their companies in setting achievable milestones before pursuing Series A funding, as investor behavior lacks consistency.

The question that arises is, amid the persistence of this market slowdown, will the wider seed market converge on lower valuations, or will we witness a continued schism in valuations, leading to asymmetrical growth in the future?