European seed investors explain how they are investing during the current economic downturn

Since the beginning of this year, we have all witnessed the economic downturn. Especially the tech stock market, and crypto has lost a lot of its value. Now investors are getting back to business after a slow summer filled with vacations instead of term sheets. We are all wondering what the 2022 downfall of venture capital will look like, with this current uncertain venture capital climate.

What is certain now is that the VC party that started in 2020 and reaches its crescendo in 2021 is over. The startup founders I meet across the Malmö Fast Track Accelerator we all ask the same thing. What does the current market mean for seed investments? Will we be able to raise capital from venture capital funds as planned?

Startups in the early stages of development are particularly dependent on access to external capital from investors. Indeed, it might be impossible to move into profitability, many of them have a lot of potential but no income yet. For most early-stage startup founders, not raising capital means the end of your startup.

Somehow, it looks like it will be impossible to raise a round just yet as valuations of tech companies in stock markets plummet. But from another perspective, venture capital funds need to deploy the record funds they have raised. With the fall in the IPO markets, it is clear that late-stage investments have been affected. But what about early-stage markets?

Compared to stock markets, trend changes happen slowly in VC. Worse still, the data to identify trends evolves even more slowly. This is especially true at the seed stage, as many wait several months to make funding rounds public.

The data has arrived for the second quarter of 2022, and it shows a drastic slowdown of 38% in dollars invested in European venture capital compared to the same quarter last year according to Crunchbase. Compared to Q1 2022, there was a sharp drop of 24% in dollars invested. However, the slowdown was clearly driven by the decline in late-stage transactions. For the European seed stage, we don’t see the same trend break. The amount invested in this market in Q2 2022 only decreased 5% quarter-on-quarter.

But what will happen now, as we enter a new investing season? Will we see the same numbers at the seed stage, when the data backlog has been caught? Or can we expect seed funding to stay strong? As I am not a diviner, I decided to ask seed venture capital funds how they plan to invest for the rest of 2022.

We asked 22 European venture capital funds how their plans have changed in 2022, primarily with the economic downturn in mind. Of the funds that responded, 96% invest in seed, 82% in pre-seed and 46% in Series A. 78% of respondents invest across Europe or globally, while the remainder invest at the regional level.

Of all the respondents, there were 43% associates, 33% directors, and 23% associates. On average, the funds that participated in the study make 10.7 investments per year. Responses were collected between June and August 2022. You can access the full report here.

When asked whether they have changed their plan for the number of new investments for this year, two-thirds say they will stick to their original plan. Clearly, Venture capitalists have funds to deploy and they continue to see opportunities in this market.

However, we can expect a decrease in the rate of one third of the funds. As 18% expect a sharp drop of 30-50% in their number of new investments. The others, 14% of respondents, foresee a lower drop of 10 to 20%.

We also asked about the reasons for the slowdown, and the most common reasons were that the fund:

  • Don’t feel comfortable placing bets in uncertain times
  • Reserve capital or time for portfolio companies instead
  • Have uncertainty about access to LP capital

When we ask about valuations, we see a clear trend that investors agree on. All funds responded that the the valuations of their new investments will decline, since no one answered “No” to this question. However, to what extent this will change is up for debate. I half believe it will be a limited number decrease of 10-20%while the other half expects a drastic reduction of 30 to 50%. This means that we return to valuations that we knew before 2020.

Not only ratings are expected to decrease, but also ticket sizes according to half of venture capital funds. As 36% expect to reduce ticket size by 10-20% and 14% by 30-50%. However, the average market decline will be smaller than for valuations. In other words, we can expect investors to start taking bigger chunks of seed money again than what we have been used to over the past 2 years.

Over the past 2 years, we have seen investors struggle to reach 10% of a company’s capital during a funding round. In 2022, we will likely see a market where major investors revert to having 15% of a company’s capacity.

In the study, we also asked how the investment criteria could have changed. In the public stock market and in late-stage investments, we’ve seen a big push towards profitability and decrease in the attractiveness of growth. Is this also the case in early-stage investments? According to our study, metrics have indeed gained in importance in investment decisions for 68% of seed venture capitalists.

However, the the growth rate continues to be as important as before for seed startups, or even a rise in power for 27% of investors. We also note that the market has an increased priority as an investment criterion for 32% of investors. This is likely because some markets are slowing down while others are experiencing drastic changes where opportunities are opening up for startups.

When venture capitalists are asked which industries they believe have lost their appeal, crypto stands out as 35% of respondents consider it less interesting this year. This is no surprise as the crypto markets have crashed.

Philipp Handel, investor at German seed fund LaFamigliawas one of the respondents who still find crypto to be an attractive market, despite this year’s crash. “We’re already seeing a slowdown in funding volume for crypto companies. But overall, we don’t think the space has become less attractive to builders. Rather, we’re seeing a re-emphasis of investors on projects that have a truly unique ambition.”

The hype surrounding consumer tech since the pandemic seems to be subsiding as a quarter of the site is a less interesting industry.

We also asked which industries have become more attractive. Climate Tech is gaining in appeal this year 38% of investors, which is probably an effect of the more urgent message around the climate crisis. However, enterprise and fintech saas are also generating interest as venture capitalists look to less risky investments in a volatile market.

If you want to read the full report, you can access it here.

Looking to the next few months, we can now say with fairly good confidence that the the venture capital seed market will not collapse. We will see valuations drop and a few fewer trades, and the crazy rounds will no longer occur. If you operate in a good market with a good team and good parameters, you will be able to increase. No need to extend your track until 2024, many investors are still there and eager to invest!