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INNOVATION BEAT

Funding for local startups crashes in 2022 along with tech stock prices

Form Energy in Somerville, which is developing advanced battery technology, raised $450 million in October, the largest venture capital deal of the year in Massachusetts.David L. Ryan/Globe Staff

Boston cybersecurity startup Snyk may be the best example of the wild ride endured by Massachusetts tech startups over the past year.

The company, which helps developers catch security vulnerabilities in new software, reached a private valuation of $8.5 billion in 2021 and put hiring into overdrive, aiming to go public soon. But early this year, the bottom fell out for publicly traded tech companies, and the opportunity to go public slammed shut. Venture capital funds still had ample resources but were less willing to invest, particularly at the high valuations of 2020 and 2021.

So instead of planning an IPO, Snyk chief executive Peter McKay found himself scrambling to reach profitability sooner. McKay cut about 20 percent of Snyk’s workforce in two rounds of layoffs. Then in December, the company was able to raise another $200 million, though at a valuation of only $7.4 billion, a rare “down round,” as it is called in the VC business.

“The market value is the market value, let that be what it is,” said McKay, who ran several startups and was a VC himself before coming to Snyk.

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McKay was willing to accept a lower valuation, but many startups would not and fundraising activity plummeted. Massachusetts startups raised $20.3 billion this year through December 13, according to data from Pitchbook. That’s down 41 percent from the record $34.5 billion raised last year, though still the second highest total ever.

“There was a slowdown as people adjusted to this new market reality,” said Lars Albright, a Boston-based general partner at Unusual Ventures. “Dollars are being deployed at a more measured pace...there’s had to be a great recalibration.”

“This year started with such intensity and then it just fell off a cliff,” said Adrian Mendoza, founder and general partner at Mendoza Ventures in Boston. “With the changes in the [stock] market, a lot of funds stopped deploying so quickly, it was like a switch turned overnight.”

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The end of the bubble plays to the strengths of Boston area startups and investors, who have always had a more conservative approach, Mendoza argued. He recalled telling a Silicon Valley VC a few years ago that he looked for profitable startups, not just fast-growing ones.

Adrian Mendoza of Mendoza Ventures on Oct. 18, 2019. David L. Ryan/Globe Staff/David L Ryan, Globe Staff

“The guy laughed at me and was, like, you New England weirdos,” Mendoza said. “How the tables have turned. Now, every Valley investor, every New York fund is talking about profitability.”

The market has been considerably worse for startups founded by women and people of color. After making some progress in attracting more VC backing during the past few years, underrepresented founders found themselves with 2 percent or less of total funding in 2022.

“It’s a precipitous drop,” said Yasmin Cruz Ferrine, co-founder and general partner at Visible Hands, a Boston VC firm focused on backing underrepresented founders. “It’s pretty meager in terms of the amount of VC funding flowing to diverse founders and to female founders. We’re actually seeing the VC pullback disproportionately affect underrepresented founders.”

Visible Hands has worked on programs with big tech firms such as Google, Amazon, and Meta. Despite recent cost cutting efforts at those companies, at least so far they have not backed off commitments to improve startup diversity, Cruz Ferrine said. “I haven’t seen any shift yet,” she said. “This would be the wrong time to de-prioritize investing in underrepresented founders.”

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While the once red hot sector of crypto and fintech startups has all but shut down, startups working on energy and climate solutions ― a strong point for the region ― are still in vogue. The largest deal of the year in Massachusetts was Somerville battery developer Form Energy $450 million fundraising round in October, according to CB Insights. Vulcan Forms, Ascend Elements, and Factorial Energy also were among the largest deals of the year, the research firm said.

The VC industry is also excited by the emergence of so-called generative AI programs like ChatGPT and DALL-E2 that can compose art and articles that compare reasonably well to human-created works.

“We’ve been excited to see what’s happening ― AI has experienced a mass breakthrough with ChatGPT and others,” Cruz Ferrine said.

“It’s exploded onto the scene,” Albright added. “We’re looking right now...at what the possible applications could be in five or 10 years and how it might disrupt and innovate in areas we haven’t even thought through yet.”

Generative AI and similar programs also have a dark side when they are used by hackers and cybercrooks, however, warns Greg Dracon, partner at .406 Ventures in Boston. He’s looking to back startups that can defend against new AI attacks.

“New attacks are surfacing to corrupt AI models and skew data and generative AI could easily become a great tool to increase the effectiveness of social engineering attacks,” Dracon said. “So while AI tech has great promise and will unquestionably do phenomenal things, bad actors will focus on exploiting it or using it for evil themselves, so we need to consider both sides.”

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Aaron Pressman can be reached at aaron.pressman@globe.com. Follow him @ampressman.