While the first quarter of 2024 proved to be more of the same for tech startups, with deal counts and fundraising still down, analysts need only look to the last cycle in a startup's life to see when the market may begin to turn around.
PitchBook's VC-Backed IPO Index, which includes every venture capital-backed initial public offering listed on the New York Stock Exchange and Nasdaq, has severely underperformed the last couple of years and remains down more than 40% since the beginning of 2022.
A rebound seen during the past few quarters, however, has closed a gap that formed over the past couple years.
Startup exits showed some positive momentum relative to recent quarters — thanks largely to the successful IPOs of Reddit and Astera Labs — but are still considerably off pace from the highs seen in 2021. And a large majority that have gone public have done so with high losses, according to PitchBook.
"A lot of factors are improving in the overall marketplace that suggests a window could open," Chicago-based Mike Lund, audit and assurance partner at Deloitte, told Chicago Inno. "Now, that may be at the earliest later in 2024. A lot of people are starting to think 2025 is when the broader market will open back up."
There were 69 Chicago-based startup deals reported in the first-quarter Venture Monitor report, released last week by research firm PitchBook and National Venture Capital Association. That's down from the 95 deals seen in Q1 2023 in Chicago, though the $805 million raised in the first quarter of this year was a step up from the $520 million raised in the first quarter last year.
Nationally, venture-capital deals in the first quarter fell to the lowest level since 2017. There were just 2,882 venture deals in U.S. startups last quarter, a 16% decline from the previous quarter and down 28% from the same time last year, according to venture-capital data firm PitchBook.
Will VC and IPO markets rebound in 2024?
One reason Adrian Fortino, managing director at Mercury Fund, thinks things look a little more sunny is that three times as much money was raised in IPOs in Q1 2024 as in Q1 2023.
"That's a good leading indicator that things will open up," he told Chicago Inno.
Fortino said that even for the Mercury Fund, which focuses on early-stage software startups — a stage that hasn't been as hurt by the fundraising decline — the lack of exits in the last 18 months has been a challenge.
"We still have companies that go through that trajectory," he explained. "There is an aftereffect that the compression of IPO market has. It can decrease or limit activity because founders don't see a way out."
Eddie Lou, named a venture partner in Chicago at Mercury Fund in 2023, added that the VC decline trickles down in a lot of ways.
"Even at the pre-seed range, angels aren't liquid anymore because the investments they put money in aren't raising capital, and all the sudden companies at the friends-and-family stage can't raise a pre-seed round," he told Chicago Inno. "I think that's probably gone from like $7 million to $8 million average pre-seed down to sub-$5 million."
PitchBook VC analyst Kaidi Gao said that until the IPO floodgate opens, it's unlikely we'll see a meaningful uptick in terms of venture dealmaking activity because a lot of value is still being trapped in those mature, late-stage companies that are unable to exit.
The dam appears to be breaking a bit with Reddit and Astera Labs, but Gao said that a couple of IPOs is not enough to indicate the reopening of the market at large.
Northbrook, Illinois-based UL Solutions Inc. also launched an upsized IPO and began trading on the New York Stock Exchange on Friday under the symbol "ULS," another indication that the frozen IPO may be thawing.
"While we're still waiting for that IPO to window open, we're actually expecting to see an uptick in terms of [mergers and acquisition] activity," Gao told Chicago Inno. "Founders are coming to rationalize that valuation level is not going to return to that 2021 level, and for some companies they are thinking that it may be time for them to think about making an exit in the form of being acquired."
In speaking with Midwest investors, Gao has found that everybody is waiting for a rebound and of course are disappointed to see the Q1 numbers, though the region seems to be doing better than others.
"If we look at a deal count perspective for the Midwest, for the first quarter of 2024, the Midwest made up roughly 1.85% of all the deals that are happening in the U.S. venture ecosystem," she said. "If you compare that with the annual metrics that we had from 2020 to 2023, it actually went up a little. In 2022 the annual level was 1.41% and in 2023 it was 1.79%."
Startups lose negotiating power
Still, Chicago's startup scene wasn't immune to some of the challenges that other tech firms faced in the past 18 months, including down rounds, flat rounds, extension rounds and insider-led rounds. The gap between buyers and sellers has put pressure on companies to move toward profitability while also maintaining growth.
Gao said that unless a really strong company wasn't subject to hype or overinflated valuation when it was raising its last round, it's unlikely the company could match its previous valuation — even if it's making progress in terms of delivering financial metrics or delivering better products.
For example, Cameo, a Chicago startup that reached unicorn status in 2021, started raising a $28 million funding round in March that was reported to value the company at less than $100 million.
Gao added that unless a founder has been able to secure multiple term sheets, they don't have a ton of negotiating power right now.
"A lot of companies are grappling between whether they should take the bullet and sign a term sheet to extend their runway or try for something like bridge financing with their existing investors," she said.
Given all the price corrections that have been seen across the tech market, some startups are finding they have to go backward in order to go forward.
