The Great Venture Capital Paradox: AI Hype Soars, Funding Drops in First Half of 2023

According to data from research firm PitchBook, global venture capital funding experienced a significant decline in the first half of 2023. This decline, which amounted to 48% and brought the total investment to $173.9 billion, can be attributed to a lack of investor enthusiasm and reduced demand due to significantly higher interest rates. Despite the success of OpenAI’s ChatGPT, which generated substantial interest in artificial intelligence (AI) startups, there was a 19% decrease in the number of deals.

Investors allocated over $40 billion to AI startups during the last six months, including a $10 billion investment from Microsoft in OpenAI and $1.3 billion in funding for Inflection AI. Among different regions, South America experienced the largest decline, plunging by 86%, while the U.S. and Europe fell 65% and 69%, respectively.

Don’t Miss:

• Until 2016 it was illegal for retail investors to invest in high-growth startups. Thanks to changes in federal law, this Kevin O’Leary-Backed Startup Lets You Become a Venture Capitalist With $100
•  Don’t just buy from your favorite brands, own them so you own the upside. Learn how Retail Investors Are Taking Stakes In Their Favorite Startups To Own The Upside

Investors point out that the higher interest rates have led to a reassessment of valuations, and the current lack of initial public offerings (IPOs) and other exit opportunities has made them more selective. This sentiment is evident in the statement of Kevin Colleran, a co-founder at early-stage firm Slow Ventures, who mentioned that he hadn’t made any investments lately. 

“I haven’t written any checks in the past 18 months,” Colleran said, “I have 30 portfolio companies that I need to help figure out how to survive. There is no point for me to add to the misery.”

Startup Funding in the U.S. and Europe 

The global startup sector has been dealing with the ramifications of the precarious economic climate, as recessionary concerns have spooked venture capitalists. 

According to PitchBook, the European venture capital market experienced a decline in both the value and number of deals in the first quarter. This was attributed to factors such as inflation, higher interest rates, and companies’ efforts to cut costs and improve profitability. Pitchbook's 2023 European Venture Report revealed a 32.1% decrease in the value of VC deals, amounting to 11.8 billion euros ($12.90 billion), and a 19.2% decrease in the number of deals. 

Funding activity has declined across all stages, with the first seed round experiencing the largest drop of 44% in the number of deals in the U.S. Many firms that secured funds in 2021 still have substantial amounts of money and see little incentive to return to a market that expects lower valuations. 

To stay updated with top startup news & investments, sign up for Benzinga's Startup Investing & Equity Crowdfunding Newsletter.

Contributing Factor: SVB's Collapse 

The Silicon Valley Bank's brutal collapse can also be attributed to the lower startup funding, as newly minted companies struggle to finance their operations. In addition, with interest rates on the rise, companies have been struggling to meet their cash flow needs as well. The uncertain macroeconomic conditions coupled with fragile banking sector has contributed to venture capitalists' hesitation towards funding new startups. 

"It's definitely going to be a very heavy, very variable year in terms of just viability of some early-stage startups," Madison Hawkinson, an investor at Costanoa Ventures, said. 

Equity Crowdfunding – The Unexpected Champion

Companies have been turning to equity crowdfunding platforms such as StartEngine and Wefunder to raise funds in the absence of venture funding interest. As investor optimism has continued to rebound over the past month with the S&P 500 index ending its longest bear run since 1948, retail investors have regained their appetite for relatively risky startup investments as well. 

KingsCrowd, a publication focused on equity crowdfunding, has published the figures for May, revealing that funds collected through Regulation Crowdfunding (Reg. CF) amounted to $23.7 million during the month. Additionally, contributions made under Regulation A+ (Reg. A+) resulted in an additional $4.2 million raised, making the overall equity deal total for the industry reach $27.9 million. Out of this, approximately 45%, or $12.6 million, was raised on StartEngine.  

Investors anticipate a moderate increase in demand in the second half of the year as more companies exhaust their cash reserves and seek funding to support their plans. Mary D’Onofrio, a partner at Bessemer Venture Partners, stated that more companies will likely come to the market to secure financing.

“More companies will have run low on cash and will need to come to market to fully finance their plans,” D’Onofrio stated.

See more on startup investing from Benzinga:

• There are more pounds of plastic in the ocean than pounds of fish. That’s why retail investors have invested over $4 million in This Startup That Invented Programmable, Drinkable Plastic That Dissolves In Water In 60 Hours

• Gamers are selling their old gaming items for millions. Learn why everyday gamers and investors are claiming a stake in their side hustle and how they invested over $1.2 million in this startup.