In The Figures that Will Move the Venture Capital Market in the Next 3-5 Years, I wrote about the correlation between interest rates & venture capital investing.

In the past two years, the correlation has grown stronger from -0.46 correlation to -0.51.

The correlation is strong enough to build a simple prediction of early stage venture capital activity in 2023.

This simple model uses the 10 year bond rate plus the amount of early stage venture capital raised in the previous year. The chart above shows the predicted invested in grey & actuals in orange. The model has a very small p-value with a pretty strong correlation R^2 of 0.63 for only 2 variables.

The model predicts about $30b in early stage VC in 2023 (assuming a 10 year rate of 3.7%). This is likely a conservative figure.

About one third of the way through the year, early stage VCs have invested about $16.5b according to PitchBook data, which would imply about $55b for the full year.

In 2022, startups raised about $75b from VCs. A number between $30b-55b would imply 30%-60% reduction in the early stage market.

I expect valuations across the industry to fall roughly in line with that number.

But it might be a bit less since the most competitive financings particularly in AI have been clearing at 2021 valuations, & the mountain of dry powder (more than $500b raised for early venture in the last 3 years) will buoy valuations through competition.

Should the Fed decide to cut rates (the bond market suggests so)[1], perhaps some smaller quantum of the euphoria of 2021 may return to venture investing.

– [1] The Fed Funds rate is the interest rates banks pays to borrow from the government overnight. It’s at 5% today. The 2-year Treasury (the rate which the government pays to borrow money for 2 years) is around 3.8%. That means the market “believes” that in 2 years the Fed Funds rate will be at 3.8%, falling 1.2% in the next 24 months.