The Post-SPAC Era: IRA Funding and VC's New Challenges

Our last post discussed the IRA’s potential to boost energy infrastructure and reduce long-term deficits—a clear win for all. However, the same cannot necessarily be said for venture capital.

During the SPAC era of 2021, venture capital saw inflated valuations and what Carta called the “Strongest year on record.” With the federal funds rate near zero, private markets experienced unprecedented levels of fundraising, larger round sizes, and minimal dilution. As we mentioned last week, the flow of capital into private markets was fueled by the low-rate environment, which made safer assets less attractive, prompting investors to take on more risk.

Fast forward to 2022, and a downturn in valuations and total capital raised was evident. Isn’t this also the period when the IRA began to take effect? Why aren’t GPs pricing the IRA into valuations? The answer lies in the macroeconomic environment. Lower interest rates make venture investments more attractive, whereas rising rates increase the hurdle rates for such investments.

This dynamic became evident toward the end of the SPAC era, as rising rates began to cool the speculative frenzy that low rates had initially fueled. Additionally, irrespective of rates, for a startup to be venture-backable, it must be able to succeed without relying on government funding. Government support should act as a bonus—"the icing on the cake," not the "batter that makes it."

Securing IRA funding is inherently challenging for startups. For example, IRA custodians often require startups to provide annual valuations of their shares held by the IRA. For startups that have previously raised rounds on SAFEs or convertible notes, this could trigger dilution events—an unappealing prospect. Early-stage companies developing energy transition technologies like CCUS, BESS, and new renewable innovations often avoid assigning value to preferred stock once sold, as doing so could create cap table issues down the line.

Moreover, competition for IRA funding is intense, particularly for startups vying against established companies with similar financing needs. Startups working on high-risk, long-term projects face even greater challenges securing IRA support. Consequently, private markets tend to react more sensitively to interest rate changes than to government funding, which can be altered, adapted, or revoked over time.

This macroeconomic caution has driven LPs and funds to reassess their investments since 2022. From 2021-2023, venture funding in the United States declined by roughly 30% year-over-year, plummeting to approximately $171 billion (in 2023) from $345 billion in 2021. This steep adjustment signaled a bearish outlook for venture capital.

As highlighted in Sequoia’s "Crucible Moment" memo, the coming years were expected to bring a murky economic environment. Sequoia advised its portfolio companies to tighten cash burn, a clear warning that raising private capital would become increasingly difficult—and they were right.