Q1 VC investment rises, with headwinds increasing for 2023

Two large deals fueled total VC dollars invested in Q1, while deal count dipped amid continued economic uncertainty and recent bank shakeups.

While VC investment in Q1 2023 improved by 37% over Q4 2022 — rising to $44.1 billion compared to $32.3 billion for Q4 2022 — recent bank failures and a weaker economic environment have dampened the overall outlook for the remainder of 2023.

For the immediate future, VCs likely will become even more selective about how they deploy capital, and we anticipate that VC investment will continue to drop off from the levels of 2021 and 2022. We may continue to see large fund flows occur, but they’re likely to be undertaken from a defensive position to shore up companies in situations where investors are doubling down. Seed and Series A rounds may become more challenging as VCs will likely prioritize existing portfolio companies.

Mega-round financing

The number of mega-round deals dropped 18% from Q4 2022, barely reaching the 50-deal threshold for those of $100 million and over, the lowest since before the pandemic. Year over year, the deal count is off by 75%. By this time last year, the market had already recorded 203 mega deals. For the third straight quarter, healthcare had the most mega-rounds by number of deals. In the current environment, we don’t expect to see a return to the days of rampant deal and dollar volume in mega-rounds, as we’ve seen in recent history. However, despite the chill in venture investment more broadly, large deals continue to get done, especially for companies with large addressable markets and disruptive innovation.

Sectors

Information technology continued to lead in terms of sector activity, followed by business and financial services and healthcare. Business and financial services would have ranked third without one of the two large deals that bolstered this quarter (a FinTech deal). Health care continued its strong recent showing.

We continue to see a decline in consumer goods, which was off 32%. Until inflation and interest rates stabilize, we expect this trend to continue. The energy sector continued to show strength, particularly in renewable energy. However, the bank failures could have an impact on climate tech companies. We will be watching closely to see how those companies interact with the banks and financial institutions that fill the gap.

Regions

VC activity in most regions, except the San Francisco Bay area and Austin, experienced a significant drop-off over last year. The San Francisco Bay area continued to hold onto its lead as the top region, accounting for more than half of all VC activity in Q1. That share would have fallen to around 33% of the total without the two large mega deals, however.

New York and Boston finished second and third. Los Angeles came in fourth, while Nashville entered the top five on the strength of a solar energy deal and a specialty health care deal that pushed them ahead of Austin. Los Angeles recorded fewer than 150 deals, the second straight quarter it failed to reach that mark.

Overall outlook

It’s too soon to know the long-term implications of the recent shakeup in banks that served the tech ecosystem. It’s fortunate that existing venture debt facilities are being honored; otherwise, start-ups would be faced with a credit crunch. The banking fallout, paired with high interest rates and slowing venture investment, means that entrepreneurs need to be deliberate about how they raise and manage capital in this environment.

This could be a painful period for many entrepreneurs. We are likely going to see more layoffs as companies review their operating expenses and try to find ways to survive until the market improves. But companies need to be careful and cut cautiously without impairing their ability to rebound when conditions turn for the better. Given current banking volatility, start-ups should take steps to strengthen their financial teams. In the current environment, companies should diversify their banking relationships, which may require more operating expertise and infrastructure.

We’ve said it before, but good companies often emerge during tough times. There are no shortage of challenges and distracting headlines in this environment. Entrepreneurs who can stay heads-down focused on executing on fundamentals will be better positioned to weather the storm.