The State of Venture Capital: A Look Toward 2025 | Ep. 546
New Trends for the New Year
Hello Avatar! Welcome to another week of biotech analysis. Today’s commentary is as always on Thursday focused on the general market update. For the week XBI was UP +2.5% and remains green at +1.5% for the year. As we step into 2025, the venture capital and biotech landscapes are undergoing significant transformations. In this edition, we explore some of the most pressing trends shaping the investment industry. From the evolving role of spinout general partners and the rise of boutique venture funds to shifts in valuation dynamics, fundraising strategies, and IPO activity, the venture ecosystem is recalibrating after the frenzied highs of recent years. We'll also examine the divergence between blue-chip biotech VC, which is adopting risk profiles more akin to private equity, and traditional venture capital, where smaller funds and non-consensus bets hold the promise of outsized returns. With liquidity challenges easing and entrepreneurial innovation showing resilience, the coming year is poised to bring both challenges and opportunities for investors and founders alike.
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BIOTECH PUBLIC MARKET UPDATE
For the week, the public indexes were both FLAT, with the S&P +0% & DOW moving +0%. For the year both remain FLAT +0% and +0% respectively. The XBI (the biotech index) comes in UP +2.5% for the week and remains +1.5% for the year.
Macro Update
The Q1 macro outlook (including for biotech) is deeply intertwined with market liquidity dynamics, and as we have been preaching the Treasury General Account (TGA) is set to play a pivotal role until the inevitable debt ceiling raise. The reason the TGA is so critical is that it serves as the last remaining lever to inject liquidity into the financial system in the absence of new borrowing. With a current balance of $721.9B, the TGA has significant firepower to keep the system afloat through Q1.
By "keeping afloat," we mean that the Treasury can sustain liquidity injections into the financial system—essentially allowing the Fed to maintain favorable conditions. And if you need a reminder, more liquidity in the system typically translates to one thing: number go up.
If you’ve been following our Thursday updates, you’ll already know that other tools for expanding liquidity include the reverse repo facility (which has been nearly drained) and increasing the balance sheet by buying bonds. With regard to the balance sheet, the Fed has been heading in the opposite direction for years now, contracting its balance sheet through ongoing quantitative tightening (QT). QT continues to remove ~$60B per month from the financial system—though this has been offset by liquidity injections from the reverse repo facility and will soon be supplemented by the TGA drawdown.
The table below from Maelstrom highlights how the TGA is projected to be drawn down to fund government operations while Congress remains gridlocked on the debt ceiling. March’s dramatic liquidity injection (incoming tax receipts), as shown in the green-highlighted row, represents a key inflection point. After this is where things start to get tight and market participants are likely to begin questioning the sustainability of the current liquidity environment. With no ability to issue new debt, the Treasury’s only remaining tool is the TGA, which, as the chart suggests, could be fully exhausted by May or June—potentially triggering significant market disruptions.
The Fed and Treasury find themselves in a delicate balancing act to maintain bond market stability. The Fed's recent rate adjustments, designed to drain the Reverse Repo Program (RRP), have injected an additional ~$237B into dollar liquidity, complementing the TGA's contributions. Together, these efforts result in a net liquidity injection of ~$612B in Q1. However, this liquidity honeymoon is unlikely to last. Once the TGA is depleted and subsequently replenished, the liquidity environment will shift sharply into reverse, likely triggering rising bond yields and heightened volatility.
Markets, always forward-looking, are acutely attuned to these dynamics. The depletion of the TGA in Q1 follows a familiar pattern of dollar liquidity surges that tend to fuel risk asset rallies. Yet, as the debt ceiling drama unfolds, the market will inevitably prepare for a liquidity crunch in Q2. Tax season and the rebuilding of the TGA will add further headwinds, creating a more challenging macro environment.
TL;DR: The market likely won’t roll over until after Q1. Afterward, it’ll be the usual “sell in May and go away,” a trend that conveniently aligns with typical biotech seasonality.
Introduction
The venture capital ecosystem is undergoing a profound transformation as it reverts to a more sustainable and structured norm after the frenzied years of 2021 and 2022. Today we explore key trends shaping the industry, including the decline in new fund formations, the rise of spinout general partners (GPs) from established funds, and the shifting dynamics of valuations, fundraising, and deal structures. Furthermore, the industry is witnessing a heightened focus on operational efficiency and value creation, as both LPs and founders demand more tangible outcomes from their investments. As we look to 2025, the venture landscape presents both challenges and opportunities for investors and founders alike.
A Retreat from the Peak
Recent data highlights a sharp decline in first-time fund formations. According to reports, the number of new funds raised in 2024 was down by 80% compared to the peak of 2021.
Of those funds launched in the past five years, a striking 75% were sub-$50 million, and only 47% managed to raise a second fund. These figures underline the difficulty of not only establishing a venture firm but also institutionalizing it and attracting repeat investments from limited partners (LPs).
The root causes of this contraction are multifaceted. A major driver has been the liquidity crunch faced by LPs, stemming from a dearth of IPOs and mergers and acquisitions (M&A) activity over the last few years. Without cash returns to reinvest, LPs have been pulling back, forcing VCs to recalibrate their strategies. This decline is not necessarily a negative development—it represents a reversion to a healthier, more stable ecosystem.
The Rise of Spinout GPs
One of the most intriguing trends is the growing number of GPs leaving large, established funds to start their own ventures. Historically, LPs have shown comfort in backing spinouts from marquee names, given their track records and institutional pedigrees. However, the current wave of spinouts is notable for several reasons:
In the past, biotech-specific platforms like Third Rock Ventures, Flagship Pioneering, and Arch Venture Partners were indispensable for their infrastructure, operational expertise, and access to top-tier life sciences deals. Today, spinout funds are replicating these capabilities by hiring selectively and focusing on niche, innovative approaches. From scientific advisory boards to partnerships with clinical development experts, these smaller funds demonstrate that operational excellence can be built incrementally.
Moreover, GPs with notable track records in advancing transformative biotech companies are attracting LPs by offering a focused and tailored approach. This shift suggests that 2025 could see a surge in boutique biotech venture funds led by experienced individuals who combine domain-specific expertise with an agile, founder-friendly model.
Valuation Trends and Market Dynamics
Valuations for early-stage startups have seen significant shifts, with the premium once commanded by certain sectors now largely eroded. In biotech, 2024 has marked a particularly tough year, with gene editing companies down 58.5% and cell therapy companies down 42.1%. These declines contrast sharply with the broader biotech index, $XBI, which has posted a modest 2.7% gain.
In parallel, AI-focused companies have experienced a stabilization in valuation premiums. Seed-stage AI valuations continue to outpace those of non-AI companies, with notable gaps at key percentiles. Despite this, the AI sector is beginning to see a cooling at later stages, such as Series B, where investor focus is shifting toward execution and scalability rather than hype. The hype-driven surges of past years are being replaced by a sharper emphasis on measurable progress and deliverables, a trend likely to extend into 2025. Together, these shifts highlight a maturing investment landscape where both biotech and AI must prove their value through results rather than promises.
Round Sizes and the Influence of Multi-Stage Funds
Round sizes have generally declined from their 2021 peaks, reflecting a more disciplined investment climate. While seed-stage rounds at the 95th percentile reached $12 million in 2024—up from $9.6 million in 2021—Series A and later rounds have seen decreases across the board. For instance, the average Series A round size dropped from $40 million in 2021 to $36 million in 2024.
The role of multi-stage funds in seed rounds has also grown steadily since 2018, with biotech-focused firms like Arch and Flagship playing an increasingly significant role. These funds bring deep sector expertise and operational support, making them formidable players in early-stage biotech deals. However, this trend highlights the challenges for smaller, specialized funds that must compete with these established giants to secure promising opportunities.
What to Expect in 2025
Looking ahead, several key developments could shape the venture landscape in 2025. A resurgence in the IPO market is anticipated to unlock fresh capital for LPs, offering them renewed opportunities to reengage with venture investments and strengthen their portfolios. Personally we have doubts if this will fully materialize in 2025.
With fewer first-time funds being raised, the venture ecosystem is likely to see consolidation, enabling established firms and successful spinouts to dominate LP commitments and create a more concentrated yet robust investment landscape.
It is also becoming increasingly apparent to LPs that blue-chip biotech VC is evolving into something resembling private equity in terms of risk and reward. While these funds offer a safer, more predictable return profile, the true mega upside—and downside—remains tied to traditional venture capital, characterized by smaller fund sizes and non-consensus bets.
This divergence highlights the emergence of two distinct products within the VC space, each catering to different risk appetites and investment goals. As this evolution unfolds, LPs are recognizing the need to diversify their portfolios, balancing the stability of blue-chip funds with the transformative potential of high-risk, high-reward traditional venture investments.
CONCLUSION
The venture capital industry is entering a period of recalibration. While the contraction in new fund formations and the liquidity crunch pose challenges, they also represent a return to a more rational and sustainable model. The rise of spinout GPs, combined with evolving valuation trends and market dynamics, underscores the adaptability and resilience of the VC ecosystem. As we approach 2025, there is reason for cautious optimism, with opportunities abound for those willing to innovate and adapt to the changing landscape. The next chapter promises to be one of reinvention and renewal, and we can’t wait to see what it brings.
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