What the looming recession means for venture capital globally and in the MENAPT region

How does the impending recession affect VC?

Scrolling through virtually any business news or media outlet these days is a bit of a downer for most individual and institutional investors. The headlines reflect the pessimistic market sentiments and have readers speculating the worst — the possibility of a major recession.

The Econ 101 definition of a recession is two consecutive quarters of reduced trade and industrial activity. Economists at leading banks like Morgan Stanley and Citigroup predict that a recession, by definition, is probable, and in fact already well underway since the beginning of the year. 

Venture Capital has had a record-breaking year in 2021 with $630 billion invested globally (according to CB Insights). Not to mention, new unicorn births accelerated — there were 62% more unicorns by Q1 2022 year-on-year compared to Q1 2021, at a total of 1,070 globally. 

Now, we all know what’s on the other side of the top of a hill, and in a similar fashion, economic cycles have periods of “uphill” movements called booms followed by “downhill” runs called busts. More of Econ 101 should be coming back to you now.

In Q1 this year with $143.9 billion of capital raised across 8,835 deals, venture funding dropped by 21% compared to Q1 last year, and by 19% compared to Q4 last year. Further, in Q2, $108.5 billion of capital was raised across 7,651 deals, according to CB Insights, which is a 27% drop compared to Q2 last year, and by 26% compared to Q1 this year. This brings the total funding for the first half of 2022 to $252.4 billion, which is not even half of 2021’s full-year count of $630 billion, despite us being halfway through the year.

What went wrong globally?

In 2020, when the world was hit with a not-so-little pandemic stirred by the Covid-19 virus, the world went into panic and governments around the world stepped in to support people by offering various types of stimuli. However, as the economic downturn was short-lived (it lasted2 months), people found themselves with higher disposable income, which in turn increased spending.

Meanwhile, due to lockdowns around the world, the supply of goods was, well, tight — to put it mildly. Brands were simply not able to keep up with the demand by increasing supplies, causing the prices of goods to go up — aka inflation. In fact, inflation is currently the highest it’s been in over 40 years in countries like the United States and the United Kingdom, at 8.6% and 9.1% respectively. Similarly, inflation across Arab countries is expected to average around 7.5% this year (according to Arabian Business).

Now, some inflation – usually around 2% – is not a bad thing, as it indicates economic growth. But, there is a line at which it becomes unhealthy for the economy — and this year, it crossed that line. In the US, this drove the Fed to issue interest rate hikes in an effort to curb this inflation —- the largest interest rate hike since 1994, with more on the way. In the UAE, the federal government has also raised interest rates in line with the US.

During this time, venture capital will not come to a halt. The reduction in investment activity will, however, make the cost of this category of capital more expensive across the market in general. This is important to ensure correction in the market when company valuations seem to be “over”-inflated.

How does the drop in global VC activity affect startups?

This slowdown seems to be in the number of deals, though, as opposed to the funding levels raised, particularly for early-stage startups. In reality, Crunchbase reports that the average startup rounds raised so far in 2022 are not dramatically down compared to 2021 in the US across Series A, B, and C funding rounds. Moreover, CB Insights reports that the average deal size globally so far this year is $21 million, which is just 16% lower than the global average of $25 million last year. That being said, early-stage deals comprise the majority of deals so far this year — at 62% globally compared to mid-stage, late-stage, and others (according to CB Insights). The way this can be interpreted is that investors are being more selective about which companies they invest in, those startups that do get funded will raise at valuations centered around business fundamentals over hype.