Key Takeaways from Fenwick’s Q2 2023 Survey on Venture Capital Valuation and Deals

Key Takeaways from Fenwick’s Q2 2023 Survey on Venture Capital Valuation and Deals

Navigating the Shifting Tides of Venture Capital Valuation

The Silicon Valley venture capital landscape is a dynamic and ever-evolving ecosystem, constantly adapting to shifting market trends and investor sentiment. The recent report by Fenwick & West LLP, titled “Silicon Valley Venture Capital Survey – Second Quarter 2023,” paints a nuanced picture of the current state of venture capital in the region.

Deal Count Reaches Seven-Year Low

The data revealed a downward trend in the number of venture capital financings in the second quarter of 2023, with a total of 162 deals recorded. This marked the lowest number of deals since the fourth quarter of 2016, indicating a cooling off of the venture capital market.

Venture Capital Valuation Indicates Down Rounds Rise Pronouncedly

Another notable trend was the increasing prevalence of down rounds, where the venture capital valuation of a company decreases between fundraising rounds. Down rounds accounted for 10% of all financings in Q2 2023, compared to just 1% in Q1 2022. This suggests that investors are becoming more cautious and are not willing to pay inflated valuations for early-stage companies.

Series C Down Rounds Surge

The rise of down rounds was particularly evident in Series C financings. In Q2 2023, 19% of Series C financings involved venture capital valuations that amounted to down rounds, up from 6% in Q1 2023. This indicates that investors are becoming increasingly selective in their investments at later stages of funding.

Early-Stage Financings Slow Down Slightly

The share of early-stage financings, specifically Series A and Series B, also saw a slight decline in Q2 2023. These financings accounted for 73% of all deals, down from 83% in Q1 2023. This suggests that investors are focusing more on later-stage companies with more established track records.

Series D Financings on the Rise

On the flip side, Series D financings showed a significant increase, jumping from 3% to 10% of all financings quarter to quarter. This suggests that investors are still willing to invest in high-potential companies that have demonstrated traction and growth.

Uneven Sector Performance: AI Surges

The report also highlighted the uneven performance of different sectors in the second quarter. Software, hardware, and life sciences companies experienced an increase in their average share price from the prior round, with life sciences companies leading the pack with a 30% jump in venture capital valuations.

In contrast, companies in the Internet/digital media sector faced a significant decline in their average share price increase, from 156% in Q1 to 32% in Q2. This suggests that investors are becoming more skeptical of companies in this sector due to rising competition and regulatory uncertainty.

The AI Effect: A Rising Star in Venture Capital Valuation and Deals

An interesting trend emerged in the second quarter: the growing prominence of AI-focused companies. Approximately 38 companies (24% of all companies) in Q2 were categorized as AI, with most of them (76% of AI companies) operating in the software sector.

This indicates that investors are increasingly recognizing the potential of AI to transform various industries and are willing to back companies with promising AI applications.

Pay-to-Play Provisions Gain Traction

The report also shed light on the increasing prevalence of Pay-to-Play Provisions in venture capital financings. These provisions, which allow nonparticipating investors’ preferred stock to convert into common stock or shadow preferred stock, have reached their highest level since at least Q1 2021.

The rising adoption of these provisions suggests that investors are seeking greater protection in case of down rounds or performance failures.

Implications for Early-Stage Founders

The findings of the Fenwick & West report offer valuable insights for early-stage founders navigating the current venture capital landscape. Here are some key takeaways:

Be prepared for a more cautious investment environment: Investors are becoming more selective and focused on companies with proven track records and strong fundamentals.

Understand the dynamics of different sectors: The relative attractiveness of different sectors may vary, so carefully evaluate the opportunities and risks associated with each market.

Consider the implications of AI adoption: AI is gaining traction, and companies with innovative AI applications may attract significant investor interest.

Be aware of Pay-to-Play Provisions: Understanding these provisions and how they impact your company’s equity structure is crucial.

The Silicon Valley venture capital landscape is constantly evolving, and founders must be prepared to adapt to changing market conditions and investor preferences. By understanding the trends outlined in the Fenwick & West report, early-stage founders can make informed decisions about their fundraising strategies and position their companies for success in the competitive venture capital market.

Key takeaways for early-stage founders:

  • Pay close attention to the overall deal count and funding trends: A decreasing deal count and a rising number of venture capital valuation that amount to down rounds signal a more cautious investor environment.
  • Be mindful of sector performance: Different sectors may experience varying levels of investor interest. Evaluate the market dynamics and potential opportunities carefully.
  • Recognize the growing importance of AI: AI is gaining traction, and companies with innovative AI applications may command greater investor attention.
  • Understand the implications of Pay-to-Play Provisions: These provisions can significantly impact your company’s equity structure and potential dilution. Consult with legal and financial advisors to fully grasp their implications.

Founders play a crucial role in steering their companies towards success in the dynamic and ever-changing venture capital ecosystem. By carefully analyzing market trends, understanding investor preferences, and making informed decisions, founders can navigate the challenges and seize opportunities in the Silicon Valley venture capital landscape.

How can Eton help?

What does this all mean for values generally and 409A specifically? A new financing certainly requires a new 409A valuation before any stock options are granted. Lower venture capital valuations likely means lower fair market value (and strike prices) for stock option grants. Some see this as a negative. However, keep in mind that generally speaking the people in a company are what make the company succeed. In light of that, perhaps it is a good time to focus on retaining and incentivizing your great people (and recruiting new talent) with lower exercise price stock options. 

Eton Venture Services is a specialized 409A valuation services firm with a proven track record of helping venture-backed companies obtain accurate and defensible 409A valuations. Our team of experienced valuation professionals has the expertise and resources necessary to deliver high-quality valuations that meet your unique needs.

Contact Eton Venture Services today to learn how the venture capital financing market may impact the value of your company and the price at which you issue options.

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President & CEO

Chris co-founded Eton Venture Services in 2010 to provide mission-critical valuations to venture-based companies. He works closely with each client’s leadership team, board of directors, internal / external counsel, and independent auditor to develop detailed financial models and create accurate, audit-proof valuations.

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