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According to the Q4â€�2022 edition of Venture Pulse, a quarterly analysis by ÀÖÓ㣨Leyu£©ÌåÓý¹ÙÍø Private Enterprise, both the number of venture capital (VC) deals and the total of VC investment in the US continued to fall despite fundraising activity hitting a record high. While there continued to be a wealth of dry powder in the VC market, many investors pulled back from making major investments.

During Q4�2022, the time horizon for fundraising noticeably moved out, with funds taking longer to fully capitalize than has been seen in recent years. As a result, total fundraising will likely begin to fall heading into 2023.

“Overall investment continued to decline this quarter, falling to the lowest levels since Q2â€�2019,â€� said Conor Moore Head of ÀÖÓ㣨Leyu£©ÌåÓý¹ÙÍø Private Enterprise in the Americas Region & Co-Leader, ÀÖÓ㣨Leyu£©ÌåÓý¹ÙÍø Private Enterprise Emerging Giants Network, ÀÖÓ㣨Leyu£©ÌåÓý¹ÙÍø International. “The combination of economic and geopolitical pressures, alongside turbulent capital markets and low IPO activity, have taken their toll on venture capital investment. However, we continue to see encouraging levels of investment in the new energy and electric vehicle ecosystems, as venture capitalists continue to align with government initiatives and incentives in these areas deemed critical to energy independence.â€�

Increasing focus on energy, ESG, and regtech investments

Over the past year, the US government has implemented legislation quite favorable to the development of the electric vehicle ecosystem and the development of energy infrastructure more broadly. This support has helped spur additional interest and VC investment in the space that is expected to be a leading focus in Q1�2023 as well. During Q4�2022, alternative energy and battery storage saw significant interest from VC investors in the US. Nuclear innovation company TerraPower raised $830 million during the quarter, while energy storage company Form Energy raised $450 million.

Renewed interest in cleantech and ESG has also helped drive investment in the US, both directly in ESG-focused solutions and in regtech solutions as companies look for better ways to understand and report on their energy efficiency and ESG activities and, in certain cases, manage their regulatory reporting requirements.

Other sectors that remained attractive to VC investors during Q4�2022 included military and space-focused solutions, B2B solutions, health and biotech.

Threshold-valued unicorns working to avoid down rounds

During Q4�2022, the US VC market continued to see startups search for ways to obtain funds without taking a hit to their valuations. A number of companies held flat rounds or conducted an extension of an existing funding round in order to raise bridge funding and potentially avoid the negativity associated with holding a true down round. Though, down rounds are expected to increase in Q1�2023.

“A lot of unicorns in the US are going to face challenges in Q1â€�2023, particularly those right at the $1 billion valuation,â€� said Jules Walker, Senior Director, Business Development, ÀÖÓ㣨Leyu£©ÌåÓý¹ÙÍø US. “These companies worked hard to achieve that status –to reach that gold bar. Now they’ll be working as hard, if not harder, to retain that status. Investors are going to have all the leverage. Companies looking to raise funding and keep their unicorn status may need to give up a lot.â€�

Cost reduction becoming normal for some, may lead to new startups

After an extended period where growth was king, many late stage and unicorn companies in the US have been forced to rein in their costs and heighten their focus on profitability. Q4�2022 was no exception as tech companies laying off significant percentages of their workforces became normal rather than noteworthy. This focus on cash management, combined with the downward pressure on valuations, has likely led to the big drop in investment for late stage deals.

“One interesting question here in the US is ‘what will happen with all the newly unemployed developers, technologists, and the like?â€�,â€� said Sam Lush, Director, ÀÖÓ㣨Leyu£©ÌåÓý¹ÙÍø US. “Will they start their own companies? Will they accept lower salaries? Will they move to some other location or embrace remote work? We don’t have the answer right now, but it could be quite exciting, particularly if it means a new cohort of startups appear in 2023.â€�

Trends to watch for in Q1�2023

• Looking forward, VC investment in the US is expected to remain subdued, except in high priority sectors, including energy and B2B solutions. We could also see large pension and sovereign wealth funds examining their investment allocations—which could affect VC investment levels later in 2023.
• Given the number of tech sector layoffs occurring in the US, particularly in Silicon Valley, talent will likely be an area to watch over the next few quarters to see how talent costs are affected or whether there is an upswell in new startups.
• IPO activity is expected to remain dead well into 2023 in the US as companies continue to delay exits. Down rounds will likely become more common as late stage companies run out of runway to delay new funding rounds. This could cause a number of unicorn companies to lose their status as their valuations drop below the $1 billion threshold—or accept less-than-optimal deal conditions (e.g., rachets) in order to maintain their position.

View the full global report here.