Tech failure reduces early-stage startup funding

The retreat reflects investors’ growing wariness of riskier investments such as startups, a significant shift in mindset in recent years, when competition among venture firms has led them to invest earlier in the startup life cycle. Funding follows a similar drag for later-stage startups, which are closer to going public and are more influenced by stock market changes.

The shift is returning more power to investors in Silicon Valley. For years, a flood of cheap valuations has been on the rise, and venture firms have spent more time researching and vetting the companies for potential founders and said they don’t miss out on deals. The pandemic has accelerated many of these trends, as demand for software services to handle businesses operating online is increasing and interest rates are at historic lows.

Earlier this year, venture capitalists were optimistic about the early-stage funding environment, even as tech companies ranging from Dordash went public. Inc.

to a snowflake Inc.

It was created. According to Pitchbook data, US early stage funds rose 50% in the first quarter.

That calculation has shifted amid a worsening macroeconomic environment and a virtual freeze on investment in more mature growth-stage startups. Venture firms that focus on early-stage investments rely on cash-rich fund managers to identify the value of their holdings in subsequent funding rounds. But many of these big investment firms either pulled deals earlier this year or pulled out of the startup market altogether amid the stock market turmoil, according to venture capitalists, raising investment levels for young companies.

Funding for seed-level deals, often the first source of external financing for companies that are still manufacturing their products, has achieved significant results. U.S. deal volume fell 11% to $3.9 billion in the second quarter — the steepest quarterly decline in nearly two years, according to PitchBook data.

“The seed and Series A funding environment is the toughest I’ve ever seen in my career managing a fund,” said Jeff Morris Jr., who manages the crypto-focused early-stage fund Phase One. “It will be painful in a short time.”

In a climate that has cooled, investors say even young startups are now expected to show they have a clear path to revenue and profit. Investors are not always the first priority for such metrics, he said, as last year’s high levels of capital and low interest rates exacerbated the competition for returns.

For more mature startups, the return on an early-stage investment follows a few months. Including express delivery firm Gopuff and virtual events company Hoppin Ltd. — which raised three rounds of financing in less than a year — several rounds have been fired in 2022. Startups across the board are also overhauling their balance sheets to save money. Expecting a tougher fundraising environment, heeding strict public warnings issued by VC firms like Sequoia Capital and Lightspeed Venture Partners.

“In this climate, my mindset has completely changed. said Anurupa Ganguly, CEO of Prisms of Reality Inc., a two-year-old education-technology startup that is looking to raise a Series A round in the fall. “When things get tight, it forces founders to be tighter.

Ms. Ganguly didn’t believe the market was big enough to influence the $4.3 million seed round she completed in March, but said it will be more important for startups to hit key financial metrics if they want to scale well. From venture capitalists.

Venture capitalists raised a record $139 billion in US-based funds last year, according to Pitchbook, and will raise $122 billion this year. They include a $1.9 billion seed fund raised by Founders Fund in March and a $2 billion seed fund raised by Lightspeed Venture Partners in July.

A large amount of committed capital means VC firms still need to find new startups, although the pace of investment may slow for some funds, said Nina Achadjian of Index Ventures. She said index partners have more time to make decisions on new investments compared to last year, when established founders dominated deal negotiations.

Some seed startups are struggling to raise Series A rounds, the level of investment where investors typically wait for businesses to show clear signs of traction among customers. Many of these companies are raising extension rounds, in which capital is usually provided from existing investors at the same rate as the previous round, Ms. Achadjian and other venture capitalists said.

Crypto startups have been hit particularly hard, with a steep selloff in established cryptocurrencies such as Bitcoin and Ethereum. Venture capitalists spent $8.4 billion in early stages globally in the second half of last year as enthusiasm for the startup sector picked up. Since then, the number has fallen sharply: Just $2.4 billion was invested in such companies in the second quarter of this year, down from $3.1 billion in the first quarter, according to Crunchbase Inc. data.

Write Berber Jin at berber.jin@wsj.com