Deals slowdown threatens to squeeze venture capital liquidity

Venture capitalists are staring down a backlog of ageing investments following a slowdown in dealmaking during the coronavirus pandemic, potentially affecting their ability to continue funding future bets.

US start-ups have been slow to find acquirers or go public, curtailing the amount of cash flowing back to investors in venture firms.

They are on track this year to complete the lowest number of sales or initial public offerings since 2011, according to the PitchBook-NVCA Venture Monitor, completing 376 transactions worth $45.3bn through to the end of June. In comparison, venture-backed companies underwent more than 1,000 so-called “exits” in each of the past two years.

The slowdown could have a broader knock-on in Silicon Valley, which has battled concerns about overheating as outside groups including Japan’s SoftBank flooded the market with capital. 

“Capital in the private market is overinflating valuations. I think that’s going to get a reality check from either the public markets or corporate acquirers,” said Cameron Stanfill, a PitchBook analyst.

Tech investors maintained a high level of activity during the pandemic, making more than 5,000 US investments worth a total of $69.1bn through June, according to PitchBook data. 

Highly valued start-ups such as the trading app Robinhood and payments company Stripe raised hundreds of millions of dollars at even higher prices, as their backers sought to double down on winning bets.

Return of capital to investors shows signs of slowing

But there are signs the flow of capital back to investors has slowed. Last year to the end of the third quarter, investors in venture groups made contributions greater than the amount paid out to them in distributions, according to the data, reversing a streak of positive “net cash flows” stretching back to 2011.

Venture firms rely on exits to return money to investors such as pensions and university endowments, allowing them to reinvest in new funds. 

Several start-ups, including the data analytics group Palantir and cloud software company Snowflake, are expected to go public in coming months, allowing early backers to pare their stakes. Meanwhile, big tech companies such as Amazon and Facebook have shown a strong appetite for acquisitions during the pandemic.

More venture capitalists were also raising cash by selling shares to investors in private secondary markets before companies are acquired or go public, Mr Stanfill said. 

Some investors said they were surprised by the number of investment deals struck during the pandemic, with relatively few start-ups raising money at reduced valuations.

“There was a maybe 24-hour period [of uncertainty], and then the market kind of came roaring back,” said Deven Parekh, a managing director at Insight Partners, which manages more than $30bn.