Preqin’s Actionability Signals model shows these companies should be looking for more funding, but will they find willing investors in shaky markets?
Preqin’s Actionability Signals model shows these companies should be looking for more funding, but will they find willing investors in shaky markets?
Companies established between 2017 and 2019 represent nearly half those founded since 2010 and identified by Preqin’s Actionability Signal model to likely be looking for additional funding over the next six months (Fig. 1). Since their founding, this cohort of companies came of age amid a venture capital (VC) boom and took advantage of the opportunities in front of them. As a collective, these North American-based start-ups raised a total of $88.3bn, or 46%, of the $190.9bn raised over the past 12 years.
Fueling this trend was a wave of demand from the broader market. VC fundraising rose significantly in the latter half of the 2010’s then into the next decade and deployed that capital at nearly the same pace. In 2017, VC funds raised $36.1bn from LPs, while deploying a total of $95.2bn into North America-based companies. By 2021, those figures ballooned to a record-breaking $126bn and $371.8bn, respectively. Now many of these portfolio companies are looking to expand on the progress those early rounds funded.
Preqin’s Actionability Signal model is a predictive model that assesses the likelihood that a company will be looking to raise capital in the next six months. The signal, a binary indicator, filters down Preqin’s database of over 84,000 private companies based on recent deal activity, performance, and employee growth to determine whether they are likely targets for GPs.
Most of the companies with positive actionability signals have already raised significant amounts of capital. Those established between 2015 and 2019 raised an average of $28.3bn per year, headlined by the $32.6bn raised by the 2018-established subset (Fig. 2).
Although those years did see a runup in the number of new companies coming to market, the resulting impact on the denominator brought the average deal sizes more in line over the period, with near $60mn per deal (Fig. 3). As this average remained within a certain band of consistency with previous deal activity, it hints that GPs were investing with beyond seed-stage confidence.
Previous funding rounds offer clues as to why this group could be looking for more capital. These companies, established between 2017 and 2019, have already seen significant funding beyond initial seed and angel stages. These early (series A) and growth stage (series B and C) investments broadcast that these companies are beyond the conceptual stages reserved for seed rounds and have a product with long-term potential. More than 95% of portfolio companies established from 2017 to 2019 saw their latest funding rounds from early or growth-stage investments.
Growth phases were notably pronounced in the 2017 and 2018 groups, suggesting that many are beyond, or a few rounds away, from the cash burn phase and turning profits. What they require now is capital to build scalability. Combined, GPs invested $27.8bn in these rounds since 2020, much of which came in the escalation of VC investment the market saw in 2021.
It may come as a surprise that they were identified as potentially in need of further funding. On the surface, the average funding round for early and growth stage funding was near $70mn, but that capital can evaporate very quickly for a company looking to expand, make acquisitions, and hire the talent needed to scale their business.
The nature of the actionability model should be noted here. It’s important to reiterate that the model identifies companies likely to be looking to raise capital. It does not indicate a degree of certainty that it will raise capital or even attract interest. The economics of 2022 are much different than the risk-on environment of 2021. And those economics will not make it easy for VC funding.
To contrast the two periods, VC funds returned 42.5% to investors in 2021, according to Preqin indexes, while the large-cap US S&P index rose 28.7%. Inflation, the resulting interest rate hikes, and geopolitical tensions that came in the year to follow were certainly risks, but still relatively unknown. By mid-September of 2022, the S&P 500 was down almost 24%, while the more tech-heavy NASDAQ Composite index was down 32%. Furthermore, most central banks have pushed base rates higher to confront rising inflation.
The confluence of these factors may give some VC investors pause as they look to deploy capital. Founders should be prepared for a less enthusiastic marketplace, particularly compared with 2021’s blockbuster. For clues of what to expect, a good place to look is the buyout market, where several major deals have been renegotiated lower amid market selloffs. Higher interest rates will lower valuations as a recession looms. It’s highly likely that VCs will be less willing to take the same risks they took just a year earlier, especially if those bets become stressed. Yet cash is king, and companies that are profitable will definitely be more attractive.
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