The venture capital industry has been hit hard by the Federal Reserve’s interest rate hikes. The once abundant era of free money has ended, causing large write-downs of many VC portfolio companies. This has led to a severe blockade in the market, making it difficult for VCs to exit their investments.
According to the Venture Capital Monitor for Q3 of 2024, exits via mergers with Special Purpose Acquisition Companies have dropped by 96% from the 2021 peak. Total exits amounted to only $10 billion in Q3, a sharp decline from the $780 billion recorded in 2021. Successful exits are essential for the venture capital ecosystem.
They allow VCs to sell their portfolio companies at a profit and redistribute earnings to their limited partners. However, the current market conditions have clogged this vital pipeline. PitchBook reports that the market continues to face headwinds despite the Federal Reserve’s 50-basis-point rate cut in September.
This will continue to pressure the exit market in the near term. The inability to translate numbers on balance sheets into realized returns has made it challenging for startups to secure additional funding rounds.
Fed rate hikes impact exits
Cash distributions to limited partners have also taken a hit. Recent data shows that cash returned to LPs is flowing at near-crisis levels, similar to those seen during the global financial crisis. The number of active venture investors has also shrunk.
As of 2024, the number of investors who made deals has dropped by 55% from 2022. This emphasizes the rise of “zombie funds”—VCs that can’t raise money from LPs or write checks to new startups, yet continue to exist by managing their existing portfolios and collecting management fees. Despite these challenges, some sectors, particularly those involving Artificial Intelligence and Machine Learning, remain exceptions in this turbulent landscape.
However, the rest of the VC industry is struggling, with many calling for further interest rate cuts to unclog the exit pipeline. While a more favorable interest rate could lure back some investments, it also poses risks. Since the Fed’s start of the rate-cut cycle, longer-term Treasury yields have shot higher, sparking inflation fears in the bond market.
The venture capital industry is at a crossroads, grappling with an unprecedented blockade in exits and fundraising capabilities. The coming months will reveal whether further rate cuts can provide the necessary relief or if the market will need to adapt to this new era of financial tightness.
