Interest Rates & VC Capital Allocation

We at Ventures Edge are going to explore VC capital flows today, the opinions below are our own.

Venture capital (VC) is an illiquid, high-risk asset class. Unlike public equities, one could argue early stage venture operates in markets driven more by sentiment and traction than traditional, equity research based fundamentals.

What influences capital allocation in VC? We want to focus on the role interest rates play. 

At a minimum, investors expect their capital to outperform inflation—meaning VC should offer a spread over risk-free returns. When rates drop, capital chases yield, making venture investments more attractive. When rates rise, alternative assets (bonds, equities, private credit) become more competitive, tightening the flow of VC dollars.

Look at 2021—ultra-low interest rates, liquidity injections, and aggressive risk-taking fueled record-breaking venture investments. Fast forward to 2022-2023, and the narrative flipped. Higher rates, lower liquidity, and a public market correction pulled capital out of VC.

Of course, interest rates aren’t the only factor. Public market performance, liquidity conditions, exit opportunities, and regulation all influence VC flows. But the key question remains:

👉 Will the forward-looking IRR of VC outperform other asset classes?

With SPY's yield exceeding that of the bulk of the VC asset class, as disclosed by public data sources, venture has become more uncompetitive in investors portfolios on a risk adjusted basis. Over time, this would force LPs to re-evaluate their allocations. If rates stay high and public equities continue to deliver strong returns, this would raise the bar for venture returns and unless the asset class delivers capital could remain constrained in this sector. On the other hand, if macro conditions shift—say, a return to rate cuts or a resurgence in tech growth— this could increase the competitiveness of VC in a portfolio.