The venture capital boom of 2020 and 2021 has largely come to an end as investors brace for economic uncertainty.

Nationwide, fewer dollars are funneling through VC funds as funders become more selective when picking companies to invest in. Funders will tell you VC has shifted from a founder’s market to a funder’s market. But startup founders have also become more cautious when seeking VC backing. It remains to be seen precisely what effect any of this will have on Minnesota, but so far, the state appears to be in line with national trends.

Across the U.S., $11.7 billion has been raised in the first quarter of this year, according to a recent report by Seattle-based PitchBook. If this fundraising pace continues through the rest of the year, it would mean the lowest total capital raised since 2017 and a 73% drop relative to 2022, the report stated. In 2022, a total of $171 billion was raised. However, most of that capital was raised at the beginning of the year, with a steep plummet in the third and fourth quarters as the country faced the threat of a possible recession.

Much of what has been seen nationally in the VC space is also reflected in Minnesota. According to a Minnesota Department of Employment and Economic Development analysis of PitchBook data provided to TCB, Minnesota VC fundraising was at $133 million across 44 deals in the first quarter of the year. The total VC raised in 2022 was $2.26 billion across 181 deals, down from $2.72 billion across 199 deals in 2021.

That all shows that the state is off to a slow start. But that could, of course, change over the rest of 2023. While deals may have slowed, they’re still happening. Minneapolis-based VC firm Arthur Ventures, for instance, earlier this month announced that it has raised an eye-popping $470 million to continue investing in software companies across the country. That comes at a time when “many traditional VC firms are reevaluating their investment models,” the firm noted in a statement.

Patrick Meenan, general partner at Arthur Ventures, acknowledged that we’ve likely entered “the worst market to raise capital in the last decade.” Yet he was still able to woo investors with a focus on “high growth” software companies, he told TCB.

“We started this thing in January and it was filled up in March,” Meenan said of the latest raise. As he sees it, that’s a “reflection of investor appetite for both high growth and capital efficiency.”

Fraught economic times

Still, this year’s news cycle hasn’t offered much comfort to investors or founders. With the crash of Silicon Valley Bank, rising interest rates, and a continued upset to cryptocurrency, both funders and founders are proceeding with caution.

Despite all of this, Reed Robinson, founder and partner of Minneapolis-based early-stage venture firm Groove Capital, hasn’t let up on investing. Groove is wrapping up its first venture fund and is about to start investing from its second $15 million fund. The fund targets primarily Minnesota businesses, Robinson said.

Still, Robinson noted that decision making has become slower and more calculated among both investors and founders.

“When you’re not quite sure if things are getting better or worse, I think human nature is to take fewer risks and really focus on your core business,” Robinson said. “That can have an impact and slow down all aspects of a founder in the startup’s journey.”

He also noted there was a lot of investor money circulating between 2020 to early 2022. Founders had more power during this time to negotiate favorable terms. Now that investors have slowed the deployment of funds and become more selective, funders have more power to negotiate terms.

In Groove’s case, though, it’s still business as usual, for the most part. “It may surprise you but we actually haven’t changed anything,” Robinson said. “We desire to be investing at the same volume that we have been investing. So our processes haven’t changed. Our eagerness to invest has probably increased, because now the deals are better.”

The continued eagerness to invest is due in a large part to the stage in which Groove invests. Because it focuses on early investment, the fund does not expect returns in the current economic climate but rather returns in the future. Robinson acknowledges there’s still some unpredictability and risk in that.

“What we’ve observed is that things have slowed down from our ability to deploy capital, but not because of anything we’ve changed,” Robinson added. “At least locally, founders have decided to wait, which has affected how many companies we have invested in in the last six months. That’s maybe unexpected.”

An alternative to VC

While venture capital may often get the lion’s share of attention, Zack Steven, CEO of tech development company Cloudburst, told TCB there are ways to challenge that model as well. While many startups look for “blitzscaling unicorn-type exits,” that is not the right approach for all companies,  he said.

Recently, Steven launched an alternative platform called the shared success agreement. The platform provides founders funding and support through time and talent. Under this agreement, people can invest time or money into companies for a share of future revenue. Instead of raising large amounts of money into venture capital funds, the shared success agreement allows interested parties people to work directly with founders, he said.

This removes some barriers to entry seen in more traditional VC avenues. “In venture capital funding or angel investing, you need to be an accredited investor and have a certain level of income in order to be able to even consider investing in those,” Steven noted. “You also need to be a company of a certain profile to be of interest to that kind of investor.”

Steven also pointed out the lack of diversity in VC funding. In 2021, white men represented 30% of the U.S. population, but 58% of all VC investors and 93% of VC dollars, according to a Forbes report. 

These are challenging times for anyone looking to start something brand new, Steven said. But he sees this period as an opportunity to rethink avenues of investment for prospective entrepreneurs.

“People are realizing there are a lot of other good businesses out there that may not have that venture scale profile,” he said. There is not a one-size-fits-all model for scaling a business, he noted.

Caution may also be prevailing in the wake of investments gone wrong. Perhaps a lesson can be learned from crypto. Globally, after billions of venture capital dollars were poured into crypto, cryptocurrency exchange FTX crashed in the last year. In the past year, we’ve also seen the downfall that can come when a business quickly scales with perhaps overly optimistic projections matched by a record IPO.

This happened with Bright Health, which at its peak was valued at $11.2 billion, making it Minnesota’s first “unicorn” startup (a company valued at over $1 billion without being listed on the stock market). But since launching with a promise to rework healthcare, it’s completely pulled out of the insurance business in all but one state. It’s exited the market for ACA plans and is instead focused exclusively on Medicare Advantage in California, alongside limited primary care offerings. The company still hasn’t turned a profit.