AI Startups Await a Mountain of Funding as “Dry Powder” Grows

Venture capital firms are sitting on a mountain of unallocated capital, known as dry powder, reflecting strong confidence in the sector despite last year's market correction. This is good news for tech startups that are facing the challenge of fundraising in an uncertain macro environment.

According to PitchBook data, global venture firms had accumulated $585.5 billion in dry powder as of the end of Q3 2022. Dry powder across private investment strategies is far higher, and near a record high of almost $2 trillion.

All this unallocated capital will eventually find its way into private markets, and particularly AI startups, which have seen explosive demand with the rise of generative AI. Here's why dry powder keeps growing, and how investors are capitalizing on it.

Venture Capitalists raised a record-high $162 billion in 2022. If this tremendous war chest had been deployed right away, dry powder levels would have dropped. But venture firms have been holding back their capital, waiting for the right opportunity.

Macroeconomic analysts see storm clouds on the horizon, with interest rate concerns, re-bound inflation fears, and a potential for lower earnings growth. This has caused venture investors to be more conservative in their investments, and allow dry powder to pile up.

In fact, US VC deal value dropped by almost a third from 2021 to 2022, according to the same PitchBook data. To startups, therefore, it may not seem like there’s a lot of money going around, but the money is actually just being temporarily held back.

That isn’t to say that new startups aren’t being funded. Microsoft's $10 billion investment in OpenAI is just one of many supersized deals in the works. 

VCs continue to raise funds for specialized funds targeting sectors, geographies and strategic deals, increasing the amount of dry powder for future investments. 

For instance, energy and power were major themes of 2022, given a myriad of growth opportunities. The US Inflation Reduction Act and its tax breaks for infrastructure developers have encouraged venture capital firms to deploy capital into those sectors. Further, geopolitical strife from the war in Ukraine to sabotaged pipelines proved to be opportunities to investors, as it reopened the debate on possible investment options in alternative energy.

Geographically, hotspots like the Middle East and Japan are attracting talented entrepreneurs, creating promising investment opportunities.

At the same time, nontraditional investors such as pension funds, endowments and family offices have been driving up dry powder levels. PitchBook data shows that these investors participated in around 74% of all US VC deals in 2022, and around 92% of mega-sized venture deals in 2021.

With the prospect of a further economic downturn, these investors are seeking to capitalize on the opportunity of even lower pricing. Of course, this attempt to time the market could backfire, and missing out on the rebound could cost them dearly.

America's largest pension fund, Calpers, failed to invest in private equity during the last recession, costing it $18 billion in potential gains. And following the dot-com crash, private equity firms were able to capitalize on a wave of discounted valuations and return a 7.5% annualized average, while the PME index annual return dropped to 0.08%.

While many private market investors are clearly sitting out this latest slump, history suggests that this may not be a wise decision. When the rebound does come, it typically happens at break-neck speed, and investors who attempt to time the market often suffer costly losses. Research by Fidelity shows that investors who missed the ten best stock market days missed out on 55% gains.

That’s why many VCs are turning to platforms like Gridline to allow them to gain exposure to private startups and other alternative asset classes. Traditionally, these investments have been reserved for an elite few, but they're now more accessible to the masses.

The forces of supply and demand dictate that dry powder will eventually find its way onto the investment landscape, fuelling the next wave of startup innovations. This may not be immediate, but it’s only a matter of time before this capital is deployed and the market rebounds.

AI startups that are prepared to ride the wave of dry powder will emerge from this correction with money in their pockets, armed with a war chest that can help them build better businesses and survive through 2023.