The venture capital industry is one of the most important aspects of global finance today and is at the forefront of the most significant trends that emerge around the world. For instance, in recent years, the emergence of ESG and the global race to achieve net zero emissions have led to burgeoning investments in clean energy, while the pandemic has accelerated the digitization process. In this decade which the World Economic Forum terms the Fourth Industrial Revolution, we will see venture capitalists scour the areas of cybersecurity, cloud storage, artificial intelligence, FinTech, and the metaverse in search of the next revolutionary idea.

Today, the US continues to dominate the venture capital scene globally. According to Preqin, 2022 year-to-date as of July has seen $99.1 billion of venture capital funding raised in the US, while only $12.3 billion and $17.0 billion were raised in Europe and Asia, respectively. 

That said, venture capital has been on a steady uptrend in Europe. The total funds raised in a year have grown from $3.4 billion in 2012 to $21 billion in 2021. Contributing to the uptick in activity has also been the introduction of the Alternative Investment Fund Managers Directive (AIFMD or Directive 2011/61/EU) in 2011, which has helped enhance investor transparency, raised operational and compliance standards, and made it easier for fund managers to market their funds across the region. The European Venture Capital Fund (EuVECA) Regulation also came into effect in 2013 to meet the specific needs of the fast-growing industry.

However, with global rate hikes portending the end to the easy money cycle, AIFMs in the venture capital space must be ready to confront a new set of challenges today.

The challenges that AIFMs in venture capital face today

In May, one of the world's most storied venture capital firms, Sequoia Capital, published a 50-page presentation warning its portfolio companies to prepare for a long and drawn-out recession and adapt to the rising cost of capital. A period of adaptation is now underway, and those that successfully adapt will emerge stronger. In such an environment, AIFMs must re-examine and improve their risk management strategies for both the existing portfolio and for new investments.

Next, despite the difficult macro environment, competition for deals remains fierce. For instance, during the past two years, it was not unusual to hear of startups getting term sheets from fund managers who have not done much due diligence, such as in the cryptocurrency space, as they had to move fast or risk losing the deal. Today, despite public market turmoil, venture capital fundraising remains brisk, and emerging AIFMs without a reputation will find it difficult to access the best deals.

Finally, the playbook in the past decade has been for portfolio companies flushed with cheap money to outspend their competitors to win market share. As the cost of capital rises, AIFMs have to come up with a playbook for their portfolio companies to thrive in this new environment.

Opportunities for AIFMs in venture capital today

Despite the fallout in publicly traded global technology stocks, AIFMs and venture capital firms have not run into major problems raising new funds in 2022. In fact, certain sectors have set new records, such as Climate Tech, which recorded $26.8 billion in venture funding for the first half of 2022. Word on the street is that demand remains strong, though investors are taking longer to complete the due diligence process. Some AIFMs will have to readjust their investment focus, and most AIFMs should plan for an extended fundraising timeline.

Next, should the global economy fall into a recession, it could actually be a welcome opportunity for AIFMs, as valuation multiples are likely to fall. AIFMs could take the opportunity to raise a new fund, as the correction in valuation multiples means that launching a new fund today is likely to be a better bet than investing during the heady days of 2021.

Looking ahead for AIFMs in venture capital

Two decades ago, the venture capital industry had a worse starting hand with the dot-com bubble crash that saw most internet companies lose 75% of their peak market value. By the end of that decade, the industry was battered again by another global financial crisis. Regardless, the industry has bounced by and changed the world. The most valuable companies in the world today are not General Electric and General Motors but are technology firms such as Apple, Google, and Microsoft.

We believe AIFMs in the venture capital industry will prosper with the opportunities in the fourth industrial revolution. However, they must re-examine and refocus on risk management, be prepared for new and more stringent regulations, and startup companies must adopt a playbook to thrive in a rising interest rate environment.