How Might Pending Federal Reserve Rate Hikes Affect Venture Capital?

This past week the Fed announced another quarter point rate hike.  The Federal Funds target rate will soon range from 1% to 1.25%, a full 1% higher than the when the Fed began its so-called “tightening” cycle in December 2015.

Question: How might the upcoming Fed tightening moves affect the venture capital markets?  Here’s some speculation.

The Federal Funds Rate

First, a look at the Federal Funds rate, from the 1970s to today.  Over the past 30 years, the Federal Funds rate has varied widely.  In the early 1980s, the rate briefly surpassed 20% – the period known as American hyperinflation.

Since that experience, inflation has been more in control.  Throughout most of the 1980s, the Federal Funds rate generally declined, almost reaching 5% by the end of the decade.

The 1990s also saw a generally sanguine Federal Reserve, moderately lowering or increase the Federal Funds target rate as the economy – or politics – permitted.

Recently, the Fed began another tightening cycle, begun in December 2015.  Given the already incredibly low rate, the question here is whether the Fed’s new attention to raising interest rates will have an effect on private markets, in particular the venture capital markets.

Source: Federal Reserve

The Venture Capital Markets

Now, to the venture capital view.  Here’s a look at venture capital deals from 1995 to the first quarter of 2016.

The number of deals generally follows the business cycle, although the sector has some historical nuances.

As any market observer well knows, the dot-com bubble saw massive growth in the number of venture capital deals, an experience that has yet to be repeated almost 20 years later.  The number of venture capital deals over the past 20 years hasn’t even gotten close.

Consistent with the general economy, activity in the venture capital industry dropped off after the financial crisis of 2008/2009, and has since gingerly recovered, although recent estimates have the industry cooling off again.

Putting the Two Together

So, is there a connection?  The simple answer is – kind of.  To any venture capital financier, it’s well known that the interest rate can affect the value of deals, although the current tightening cycle is still so low that the interest rate is likely to have only a very small impact on the attractiveness of venture capital deals.

What seems to be more present in the data is the overall economic conditions rather than the state of the Federal Funds rate.  Should economic conditions continue to improve, then venture capital markets will likely continue to expand regardless of what the Federal Reserve decides to do with the Federal Funds rate.

Conclusion

Overall, in looking at the Federal Funds rate and the historical performance of the number of venture capital deals, it’s unlikely that further tightening by the Federal Reserve in the coming year will have any measurable impact on the state of the venture capital markets.  Instead, the overall economic growth picture will likely have the larger effect.