Sep 14, 2023

These fledgling companies had been insulated against the ripple effects of the stock market crash. Some megafunds and solo venture capitalists are slowing down, making it harder to get capital. For the past 16 months, funding to seed-stage startups was a rare bright spot in an otherwise grim venture capital landscape, which has seen a sharp pullback in investment. But now, that's no longer the case, data and experts say. There were 441 seed rounds recorded on Carta in the second quarter of this year, the slowest quarter for deal activity since early 2019. That's down 41% from 745 deals in the same period a year earlier. And it wasn't just the number of seed rounds declining, but total cash raised also fell to $1.6 billion last quarter compared to $2.9 billion in Q2 2022. Those figures point to a stark reality for the youngest and most vulnerable startups, which, up until now, had danced around the initial fallout of the funding drought. They're now jostling for investment as more founders go to pitch their businesses for fresh funding this fall, and the pool of willing backers appears to be declining. In a single week in August, Jenny Fielding, a general partner at Everywhere Ventures and a super-connector on the New York tech scene, said founders and investors sent her more than 70 deals to review. She joked that she's either very good at her job or, at last, funding for the earliest-stage companies is harder to come by. "So many people are coming to me because the options are getting fewer and fewer," Fielding said. "The usual suspects are tapped out." Startups are feeling the crunch as investors, ranging from megafunds to solo venture capitalists, adapt to a new fundraising landscape. Funding for early-stage startups leveled off in the second quarter of this year. 'The tourists have gone home' In the heady days of the pandemic, venture firms known to invest at later stages piled into the seed market. They sought to secure less expensive stakes in the most promising startups as early as possible, so they had an inside lane on the hottest companies as they scaled. Investing at earlier stages is riskier but offers the opportunity for bigger profits. Firms like Andreessen Horowitz, Sequoia, and Greylock Partners tried to go earlier and earlier — raising more than $1.1 billion across three dedicated seed funds in 2021. But the honeymoon didn't last. Their interest started to wane as rising interest rates and rampant inflation led the value of publicly traded tech stocks to fall in 2022, and the correction rippled into the private markets. The pace of dealmaking slowed, valuations softened , and startups could no longer count on funding from venture firms flush with capital and hedge funds hoping to get in early on the next Airbnb. The crash threw multistage firms into a mode of portfolio triage, setting aside cash to bolster their existing companies. "A lot of multistage firms that were playing for a bit in this space have realized that they got to focus on their core, so they're not making as many seed investments," said Marlon Nichols, a cofounder and managing partner at MaC Venture Capital . He added that dealmaking tends to slow down in the summertime anyway. Lily Lyman, a general partner at the Boston venture firm Underscore VC, put it succinctly: "The tourists have gone home." Founders are also feeling the absence of up-and-coming investors — solo capitalists, super angels, and first-time fund managers. Multiple investors said these folks are slowing down because it's become exponentially harder for them to raise new funds as well. They're doing fewer deals to make their last funds stretch further, into 2024 or 2025 when conditions for fundraising may improve. "Fund managers like us, we also know how hard it is to raise money," said Brian Sugar, who closed a $33 million venture fund this past spring. Sugar Capital had set out to raise $75 million for the fund, its second, but reduced the target size last summer, according to Sugar. "So if you have $25 million left in your fund, you want to make that last into when the market gets better," Sugar said. "It's healthier investing where you're really, really taking your time placing your bets, because the scarcity of capital is real across the board." Extensions abound The supply of capital is dwindling while demand is ticking up. That has to do in part with a greater number of seed startups trying to raise extension rounds, multiple investors said. When capital dries up, many companies put off raising their next priced round in favor of doing an extension, which is when a company closes new funds, typically from existing investors, at the same terms as the last round. Extension rounds are taking more and more share of seed funding, accounting for 40% of seed rounds on Carta in the second quarter of this year, according to Peter Walker, head of insights at Carta. Bridge rounds are taking more and more share of all rounds on Carta across stages. "There are more companies than ever that need that extra cash in order to keep runway alive and make it to the next milestones, and so investors, instead of having to have that extension conversation with say, 20 or 25% of their portfolio, they're having to have it with 60% of their portfolio," he said. "And then they have to choose among their portfolio companies … which ones are we going to double down on?" In August, Insider first reported that lending startup Captain is shutting down after it tried unsuccessfully to raise an extension round from existing investors this spring. The two-year-old startup had previously raised $107 million across equity and debt capital. All of this points to a Darwinian moment for startups , threatening the survival of hundreds of startups. But it's not all bad news. Carta data shows the median seed valuation hit $13.7 million in the second quarter, which is significantly higher than any quarter prior to 2021. That figure has been buoyed by the artificial intelligence startups that are able to secure extremely high valuations even in a downturn. "The founders that are raising seed rounds are raising them for decent cash and at decent valuations — healthy on both fronts," said Peter Walker at Carta. "There's just fewer of them doing that." Sign up for notifications from Insider! Stay up to date with what you want to know. Subscribe to push notifications