Venture capital faces a challenging period with the decline of "megafund" investments

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Recent data indicates a persistent downturn in venture capital fundraising in the first quarter of 2024, as exit strategies become scarce, impacting fundraising initiatives.

Venture capital is confronting difficulties in securing funds, marking a departure from the "megafund" era and predicting a deceleration in startup financing in the foreseeable future.

In the initial quarter of this year, venture capital firms globally managed to secure $30.4 billion from sources such as university endowments and foundations, a notable decrease from the previous year, which was already the lowest since 2016, as reported by PitchBook , a provider of private market insights.

Venture fund investors, also known as limited partners, have become more conservative in their spending due to rising interest rates, a slowdown in startup exits like public listings and sales, and diminishing returns from venture capital managers.

Kaidi Gao , a venture capital analyst at PitchBook , explained, “The prolonged slowdown can primarily be attributed to the lack of exits.” A revival in public offerings or sales is essential for LPs to recover their investments and reinvest.

Gao also mentioned, "Without significant improvements in the exit market, we anticipate ongoing challenges in fundraising, which will likely exert downward pressure on dealmaking."

Since 2021, when venture capitals amassed $555 billion, fundraising activities have sharply decreased. Last year, they gathered only a third of that amount, and the downward trend continues, setting venture capitalists on track for their least successful fundraising year since 2015.

In the United States alone, only $9.3 billion was raised in the first quarter, about a tenth of the total raised in the previous year.

A leading US foundation's chief investment officer commented, "While we aim to support our partners, we must avoid financial pitfalls." He highlighted that, despite issuing larger checks during the market's peak, the stagnation in exit activities has left many investors without returns, making it "a difficult equation for numerous investors."

The slow pace of fundraising forebodes a challenging time for startups that depend on venture capital for growth in their early stages. This represents a stark turnaround from 2021 when VC firms spent a record $747.5 billion, a feat made possible by "megafunds" - investment pools ranging between $5 billion and $10 billion, which spurred an unparalleled growth period for startups.

PitchBook now believes the time for such large-scale funding vehicles might have passed, as first-quarter data suggests a diminished interest in today's market.

Major investors from the boom period, including Tiger Global Management , Coatue , SoftBank , and Insight Partners , have reduced their fund sizes and slowed investment rates.

Tiger Global concluded its 16th fund last week, securing $2.2 billion in commitments, a reduction from its previous $12.7 billion fund raised in 2021. Similarly, Insight Partners, after raising $20 billion in 2022, has scaled back its current fund's ambitions.

One chief investment officer speculated, "I would be very surprised if the industry hasn't contracted by half in five years. The absence of returns... often, the severity of a downturn is proportional to the prior bubble's extent, suggesting we may face a harsh period ahead."

Venture capitalists are now hopeful that advancements in artificial intelligence might present a unique opportunity, potentially redeeming past overextensions, as noted by Venky Ganesan , a partner at Menlo Ventures . He stated, "The venture capital community is eagerly pursuing the AI unicorn. Success in this pursuit will distinguish the successful from those relegated to obscurity."

Despite having significant unallocated funds, venture capitalists have been cautious about investing in startups affected by the current higher interest rates.

Their focus is increasingly on guiding portfolio companies towards exits, enabling them to return capital to their limited partners.

Recent successful public offerings, such as those by Reddit, Inc. and Astera Labs , alongside Rubrik's IPO filing, have sparked optimism for a revival in the US IPO market. However, Gao warns that a few successful debuts are insufficient for a full market recovery.

She recalled, "The public offerings of Klaviyo and Instacart last September generated excitement about a resurgence of IPOs, yet market volatility persisted. A successful IPO is not just about a grand debut; we need time to assess if performance stabilizes."