Global venture capital remains well-positioned for stronger long-term growth, despite the divergences in purchases in mid-2022 as central banks sharply raise interest rates in response to rising inflation.
Venture capital fundamentals remain strong, even after sharp declines in 2022 transactions, acquisition values and fund sizes. The sector holds the 3.7 trillion dollar ready-to-invest fund
Retail investors, who make up half of global asset wealth, will be venture capital’s next driving growth engine
Bain thinks venture capital should be positioned around organic growth and expanding margins as high interest rates persist
The global energy transition and web3 present both challenges and opportunities for venture capital

According to the results of Bain & Company’s 14th annual Global Venture Capital Report published on February 27, 2023, global venture capital; Despite the sudden negative effects caused by the rising inflation and interest rates, as well as the economic turmoil and uncertainties, the trend towards stronger and longer-term growth continued in 2022 as well.

The report highlights that 2022 is still the second strongest year in venture capital history, despite the divergences in acquisitions, sales and fundraising triggered by a series of rate hikes by the US Federal Reserve in response to sharply rising inflation in the middle of the year.

Bain’s research reveals that the fundamentals of the sector are strong and resilient, although the recession in June after long-standing macroeconomic shocks has set a picture that could significantly slow down the stable and attractive trajectory of the venture capital industry that has been going on for a decade. The report also highlights the potential for the venture capital sector to become even more attractive to investors looking to go beyond the constraints of the markets, despite changing economic fluctuations.

Bain also evaluates that, unlike the 2007-08 period, when the global banking system was on the verge of collapse, the basic investment thesis for the future growth of venture capital remained intact and the current conditions did not include any situation that the sector could not overcome before.

Hugh MacArthur, Head of Global Venture Capital Division at Bain & Company, expressed his views with these words: “Although there is still an ongoing slowdown in activity this year, the long-term attractiveness of venture capital for investors still remains valid. As purchasing activity starts to recover in 2023, the sector maintains its good position for long-term growth. Despite the decline in deal, exit and fundraising activities, 2022 was the second best year in history. There is undeniable uncertainty in the global market, but this is a situation that venture capital has faced before and can manage to the end.”

Examining the current and future challenges of the industry, Bain’s analysis highlights that it is clear strategic “perspectives” rather than economic conditions that will re-energize the purchasing space, even if interest rates remain high for longer.

In the report, Bain stated that the industry closed the last year with a record fund accumulation of 3.7 trillion dollars; He draws attention to the lessons learned from the previous crisis, as investors focus on managing and mitigating risk rather than panicking to help them get out of this downturn. According to the results of the analysis, leading players will continue to find new and creative buying opportunities and remain aggressive, taking into account macroeconomic conditions.

Rebecca Burack, Head of Global Venture Capital at Bain & Company, said, “Although there is a noticeable disruption in the markets, it is possible for the investors to position themselves in a way that they can make new acquisitions that they can continue in a healthy way under various conditions. The best funds can do this even with fewer purchases. While winners focus on proven investment thesis areas, investing in areas and industries where they have the highest expertise and confidence will be critical to their success. We have seen in the past that investors following this strategy have achieved very strong returns; Therefore, staying in the game is important for all stakeholders of the industry.” said.

The market is ready for a revival, although there will be a record decline in 2022

Bain’s report lays out the trajectory of the far-reaching economic and geopolitical turbulence of 2022 and its impact on the venture capital sector, which he believes bears the brunt of the macroeconomic headwinds.

After the acquisitions of 1 trillion dollars, which represented a stunning 12-year increase for the sector in 2021, reached new record levels, venture capital activities increased by 35% in the global acquisition value (excluding add-ons) last year with the sudden break in mid-2022. fell sharply to $654 billion. In this process, the total number of purchases decreased by 10% and was completed with approximately 2,318 units.

While total purchase values for 2022 historically represent the second best size in the market, this was mainly due to the extraordinary acceleration in the first half of the year. While the sharp decline in purchasing activity and values in the second half of the year was felt in all geographies and most sectors, it was exacerbated by repeated market closures in Asia-Pacific due to Covid restrictions.

Bain states that the picture of the purchasing market at the end of 2022 will be determined by the unwillingness of banks to lend to large leveraged transactions since the middle of the year, with the rise in interest rates and the intensification of economic concerns. Across the US and Europe, loans used for leverage fell 50% to $203 billion.

As a result, there has been a decline in high leveraged transactions, which have increased purchase sizes for years; Having climbed steadily every year since 2014, reaching a record $1.2 billion in 2021, the average company acquisition value fell 23% in 2022 to $964 million. While this reflected an increasing share of smaller-scale acquisitions and acquisitions of small companies for consolidation, which accounted for 72% of North American acquisitions, it turned towards investors and funds that follow the “buy and grow with consolidation” strategy.

Bain’s analysis also reveals that the decline in venture capital in 2022 also affected growth capital and late-stage venture investment, which were the most active segments before. Total purchase value in these segments fell 28% to approximately $644 billion. Along with the readjustment of investors’ risk appetite and the conservative moves of venture capital partners (GPs) to protect their valuable cash reserves, the rising interest rate environment has reduced actual activity by increasing purchase discount rates for future returns.

Bain’s analysis shows that company sales fell more sharply than investment activities. While every channel is falling in terms of sales; Acquisition-backed outflows fell 42% to $565 billion, while growth capital outflows fell 64% to $312 billion. The declines reflected sharp declines in share sales to the IPO, as well as a nearly complete close with a 58% drop in fund-to-fund purchases. While sales to strategic buyers were above the five-year average, largely due to the resilience of corporate earnings, they still closed 2022 down nearly 21% year-on-year.

It is seen that the venture capital fundraising outlook continues to rise excessively, while the new fundraising fell 10% below the 2021 levels to $1.3 trillion, the second highest record level, due to the worsening conditions and decreased confidence last year.

Despite all the declines in purchasing, sales and fundraising over the past year, a turnaround in macroeconomic conditions is impossible to predict with certainty, but the long-term outlook for venture capital is promising and shows that it can strongly support the anticipated rebound. Bain’s work also addresses some of the key industry trends and themes that will be important for further growth in the venture capital industry.

Venture capital’s next major growth engine: Representing half the global wealth size, individual investors wealth:

According to Bain’s report, the new major growth engine for venture capital is expected to be individual investors and assets. The report states that individual retail investors’ wealth (estimated at between $275 and $295 trillion) represents roughly 50% of all global assets managed with funds, but only 16% of that capital is held in alternative mutual funds; shows that this segment represents a huge and untapped market for venture capital managers who want to maintain double-digit growth as the industry matures.

Bain finds that funds that are already chasing retail investment markets are moving quickly, forcing the rest of the industry to make choices about whether to “get in the game” and their positions. At the same time, individuals with high wealth aggregates and their investment advisors are increasingly attracted to alternative investments as they find diversification options and higher returns for public equity and debt than traditional markets would offer.

We are observing the launch of many funds that allow individuals with high wealth sizes to access alternative asset classes, banks and investment advisors exploring new options for their clients, and the FinTech industry trying to adapt tools and solutions to facilitate this process. But Bain warns that this new growth area also includes tough learning curves for participants who want to run this channel at scale.

While the high interest rate environment continues, venture capital needs to be on the axis of investment theses that can create rapid organic growth and margin expansion.

According to Bain’s report, the combination of high interest rates and inflationary pressure that has emerged since 2022 poses a double threat to venture capital and investors.

In the analysis underlining the difficulty of estimating the uncertain course of prices and inflation; A number of strong trends remain, including rising material costs due to an aging population, cuts in government budgets and disruptions in the global supply chain, and trends to move production into the country. It seems that the era of historically unprecedented near-zero and even negative interest rates is over, and thus investors have to take on the risk of higher interest rates.

In this context, the report finds that this situation creates a new necessity for venture capital investments to increase margins in target companies and to create value through organic growth. Although venture capital returns have largely resulted from increases in the valuation multiplier in recent years, this indicates that venture capital partners cannot rely on the assumption that companies will have higher valuation multipliers in the future, and returns will have to be sought through growth in earnings (EBITDA) despite the complicating effect of market expansion and inflationary cost pressures.

Bain Turkey venture capital and M&A leader Volkan Kara emphasized that it is very risky to expect multiplier growth except for companies that focus on innovative, game-changing new technologies in the upcoming global recession and stagflation period. He pointed out that it will depend on more traditional methods such as increasing productivity, vertical and horizontal integration, increasing operational efficiency, and effective working capital management.”

Bain’s report states that venture capital firms that will be successful in this challenging environment; It concludes that it will be necessary to adapt to these new macroeconomic pressures, including investing in automation, supply chain diversification and cybersecurity, and managing company balance sheets against the risk that interest rates could stay “higher for longer”. In addition, when determining investment areas, venture capital players should target customer groups and sectors with lower price sensitivity. Finally, the report reveals that many companies will limit future market expansion, while venture capital will need to focus more on organic business growth, as factors such as emerging new technologies, weak GDP growth and a stagnant or declining population.

The global energy transition and web3 present both challenges and opportunities for venture capital

The search for net zero, the global energy transition away from carbon-based fuels, and the growing influence of web3 despite the current hyperbole and turmoil in the crypto world, and the challenges and opportunities for venture capital are among two other key areas explored in detail in the report.

Bain’s analysis suggests that pressure on venture capital firms to decarbonize portfolios; Emphasizes intensification in 2022 as regulators, consumers, B2B customers and investors increase their calls for change. Bain also notes that the race to develop new alternative energy sources and other low-carbon solutions has shaped a generational opportunity to put capital to work. The report highlights that the energy transition will require trillions of dollars in new capital. While uncertainty regarding regulations, the pace of change, policy and other issues will remain, venture capital and equity partners predict that such uncertainties cannot overshadow action. Instead, companies need to build on their experience, expand their capabilities, and nurture networks that enable them to turn change to their advantage.

Our co-partner Armando Guastella said, “As in other countries, Turkey is now accelerating in its decarbonization journey. As a result, today there is a great need and related demand for investments in favor of ESG and especially for Energy Transition related projects. Several initiatives have already been identified that support specific objectives across five macro sectors: Transport, Power Generation, Civil Buildings, Industrial Processes and LULUCF (LULUCF – land use change and forestry). said. “However, more solutions will be needed to reach the net zero target by 2050 or beyond. He added that when supply can meet current demand, this will be an important opportunity for Türkiye and investors.”

Bain thinks venture capital needs to overcome the challenges posed by web3 as well. According to the report, despite the current “crypto collapse”, the blockchain technologies behind crypto, commonly known as web3, will continue to exist and have far-reaching impact in business and markets. Report; whether it is someone investing in next-generation IT infrastructure, a fund manager doing due diligence on traditional companies exposed to the web3 impact, or a venture capital strategist evaluating new fund types and distribution channels; Since web3 is very likely to emerge as a critical theme in the next 10 years, it is stated that it is time for many funds to build experience in this field and evaluate their tools to benefit from the resulting technological changes.

Source: (BYZHA) – Beyaz News Agency