What Just Happened – Part II?

The National Venture Capital Association released the 2Q14 fundraising data a few weeks ago which makes for fascinating reading when compared to the 2Q14 VC investing data. While sentiment is meaningfully improved from the depths of the Great Recession of a few years ago, analysts were surprised that the amount of capital raised was actually down 19% from 1Q14; that is 78 venture firms raised $7.5 billion (data are slightly revised since the initial press release) as compared to 63 firms and $9.1 billion in 1Q14 and 55 firms and $3.3 billion in 2Q13. Obviously quarter-to-quarter variations are interesting but may not tell the whole story.

Most VC’s will tell you that conditions have improved – clearly with greater liquidity (i.e., distributions to LP’s) from stepped-up IPO activity and M&A transaction volume comes greater investor confidence. Some also expected to see a greater impact on fundraising volumes due to the ability for firms to now publicly solicit accredited U.S. investors (see 500 Startups) but that has yet to be a meaningful contributor to overall activity. Arguably the rising tide is not lifting all boats in the same manner. The VC industry continues to be dramatically redefined and the battle between large and small firms continues – the average size fund raised was $95 million, while the median was $28 million thus hinting at the underlying structural changes.

  • The top ten funds raised this past quarter collected $4.4 billion or nearly 60% of the total amount raised, implying an average fund size of…wait for it…$440 million; this is skewed by the largest fund raised by Norwest Venture Partners clocking in at $1.2 billion.
  • There were only nine funds raised between $150 million and $300 million, which had been the “bread and butter” fund size of the VC industry, especially if you think in terms of the “$50 million per partner per fund” metrics.
  • There were 59 funds raised that were less than $100 million in size and in aggregate they collected $1.5 billion (average fund size ~$25 million)
  • Notably there were 38 funds raised which were less than $25 million in size (and of that, 24 were less than $10 million in size – so nearly a third of the funds raised were tiny).
  • The 20 first time-funds raised $666 million (bad omen?); the largest of which was $172 million (Lightstone Ventures) – the average size of first-time funds was $33 million. Maybe LP’s are not really “all-in” yet which underscores the stickiness of existing venture brands.

What continues to be so confounding is the duration and depth of the “VC funding gap.” The venture industry for more than six years has invested at a pace far outstripping its ability to raise new capital. Clearly the lines below must converge at some point, and rather dramatically. Part of this can be explained by non-VC firms investing actively in VC deals – that is hedge funds and angels who would not normally be counted in the funds raised data. Simply annualizing volumes through the first two quarters of 2014 it appears that the VC industry is on pace to raise $33 billion and yet the industry looks like it will invest close to $45 billion. That gap existed before 2008 and has endured.

Funding Gap 2Q14

Interestingly this phenomenon is not in all markets. In fact Chinese VC’s invested $2.8 billion into Chinese companies this past quarter (as compared to $1.4 billion in 2Q13) while Chinese VC firms were able to raise 13 new funds totaling $3.1 billion.

So what should we expect for returns from this investment period? While it is obviously too early to call it, the VC industry has had trouble in the past absorbing too much capital, too quickly as suggested in the below analysis (prepared by Michael Nugent at the Bison Group) which looks at the average size commitment by LP each year; LP’s tend to pile into VC funds on the heels of strong vintage years. Extraordinary returns tend to be highly correlated to robust public capital markets but are also impacted by over-eager private capital markets investing at arguably an unsustainable pace.

Global VC IRR August 2014

Good thing the level of innovation is unprecedented today, entrepreneurs are addressing global markets while building economically sound businesses – now should be different – or not.

 

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And They Said It Couldn’t Get Any Better…

And for that reason I am growing more concerned. The 2Q14 VC investment data just released in the MoneyTree Report prepared by the National Venture Capital Association with an assist from PricewaterhouseCoopers and Thomson Reuters details the $13.0 billion invested in 1,114 companies over the last three months. This is the most dollars invested in a quarter since 1Q01 (and we know how that ended). This is almost 34% more than was invested in 1Q14 and a ridiculous 80% more than 2Q13. As you will see, this quarter was bigger and better than recent prior quarters across almost any dimension.

Year-to-date the VC industry has invested $22.7 billion, more than all of 2009 during the depths of the Great Recession. And while the number of deals this quarter was relatively flat, the amount of dollars invested, amount per round, pre-money valuations – all spiked considerably. Quite clearly VC’s focused on more mature, more established companies, and more often than not in software companies in Silicon Valley. Arguably the data probably include non-traditional VC’s such as hedge funds, private equity firms “going down market” and maybe some offshore investors who were out in force this quarter – and who often show up late in a cycle.

So there a few questions I struggle with as I stared at the data this weekend: are some of these deals “venture deals?” That is, when a company like Uber raises a $1.2 billion round should we include that in the analysis (later I strip it out to normalize for the “Uber effect” and yet many of the conclusions still stand). Second, when so many companies espouse the “lean start-up” mantra, why then are round sizes spiking so dramatically. Lastly, as Christopher Mims of the Wall Street Journal so brilliantly pointed out on July 7, 2014, the data suggest that VC’s have continued to forsake industries which do as he states “basic research and development that transforms lives, in fields such as energy, medicine and food safety.” This last issue is profoundly important and merits much greater scrutiny – at another time perhaps – but the data arguably supports the concern.

And the VC industry has shown that it has at times an “absorption” problem – that is, too much capital too quickly more often than not leads to too many look alike companies all beating each other up over small emerging markets, ensuring only few will be successful.

All of this activity reflects increased liquidity in the system with promising IPO activity (see biotech sector) and strong M&A volumes but also at a time of accelerating recovery in jobs creation and overall compelling real economic growth with benign inflation. Increased manufacturing productivity growth of 3.2% this year (according to ISI Group), when it has consistently been well below 2.0% per annum for the past five years, underscores the benefits of a robust tech economy. But I am reminded that the average bull market runs 57 months with the S&P 500 stock index increasing 165%; this current bull market is now 63 months old and stocks have increased 186% – again, how much better could it get?

So what do we see in the 2Q14 data?

  • Software category absolutely killed it – there was $6.1 billion invested in 454 software companies with average round size of $13.3 million. Five of the top deals were software companies and consumed $1.8 billion of that amount (taking those five companies out of the mix – Uber, Lyft, Nanthealth, Anaplan, New Relic) the average round size of the remaining was $10 million. In 2Q13 the average size was $6.2 million – nice step up.
  • Lights, camera, action – media and entertainment captured $1.0 billion of the dollars this quarter which was just below a doubling of the prior year’s second quarter.
  • Consumer Products/Services pulled in $553 million in 58 companies
  • Healthcare held its own – all of healthcare (biotech, devices, services) represented $2.6 billion of the quarter’s total as compared to $1.8 billion in 1Q14 – the difference almost entirely due to an $800 million increase in biotech activity. The average size biotech round in 2Q14 was $15.0 million.
  • Hardware categories like Computers, Electronics, Networking, Semiconductors and Telecom together captured $726 million across 57 companies ($13 million per) which used to be the bread and butter for venture investors last decade.
  • And Energy made a modest recovery scoring $717 million across 68 companies; this is a category that was all but left for dead over the past few years.

The other important theme that was emerging over the last few years was the rotation away from Seed stage investments to Later stage rounds. And while that trend continued, there are some surprising observations buried in the data.

  • Expansion stage dollars invested spiked 53% last quarter and was 44% of all activity; average round size was $18.7 million. In 2Q13 Expansion stage was 31% of the total with average round size of $9.5 million – that is a very big jump.
  • Early stage investing increased 17% on a dollars basis and 9% on a deals basis in the quarter with average round size of $7.3 million. There were 522 Early stage investments or 47% of the total number of deals.
  • Seed stage continued to fade away – while Seed dollars increased 46% and the number of deals increased 20% from the prior quarter, Seed stage was 1.4% of all dollars invested – down from 3.3% in 2Q13. There were only 55 Seed deals recorded in 2Q14 (which actually strikes me as under-reported frankly). Average size Seed round was $3.4 million – which doesn’t even really feel like a seed.
  • Later stage represented $3.2 billion invested in 229 companies, an increase of 25% and 19%, respectively.
  • In aggregate “First Time” investments was $1.9 billion or 14% of all dollars invested; this measures how much capital was invested in companies raising their first VC round. This was a 20% increase over 1Q14 – which may be read as an increase in risk tolerance by VC’s. Worthy of consideration.

The other phenomenon, and not necessarily a good one, is the geographic concentration of the VC industry. Not surprisingly Silicon Valley continues to take market share – accelerated by the “Uber effect” – at the clear expense of secondary and tertiary markets.

  • Silicon Valley rocks – $7.1 billion was invested in Valley-based companies or 55% of the total dollars (this had been 51% in 1Q14 and 42% in 2Q13, respectively). This is 5.7x New England and New York Metro, which were within $49 million of each other this past quarter at around $1.2 billion each. All three regions together captured 74% of all dollars invested.
  • Notwithstanding Silicon Valley’s dominance the region “only” represented 33% of all deals done (vs 55% of dollars invested). Does that suggest a “reverse brain drain” – that is, as my distant relative Horace Greeley may have once said, “Go West, Young Entrepreneur.” Do newly financed executives feel that they need to move to the Valley to scale their companies? Or are Valley companies able to raise more dollars per round? Or VC’s support those companies longer?
  • Coming in at number 4 was LA/Orange County at $538 million or 4.2% while Texas was number 7 with 2.7% share.
  • Funny state facts: 30 states saw less than $50 million invested within its borders in 2Q14; 17 had less than $5 million invested and 6 had $0 million invested. Twenty two states had less than 3 companies raise venture capital in 2Q14.

To the extent innovation represents growth, and VC’s finance that innovation, this concentration risks leaving important geographies behind.

 

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United Arab Emirates – Silicon Oasis Stuck in a Sandstorm

A few weeks ago I returned from nearly a week in the United Arab Emirates – both Abu Dhabi and Dubai. I held off writing this as I watched the escalation of compounding tragedies in Israel, Iraq and Syria with foreboding and yet morbid fascination. As I continue to reflect on that trip I am struck by the profound sense of optimism the Emiratis projected in spite of their surroundings. As the US Ambassador to the UAE, Ambassador Michael Corbin – a spectacular gentleman – shared over breakfast the UAE is a “beacon of hope in the middle of a region in transition.”

By far the most striking elements of the trip (not including the massive Sheikh Zayed Grand Mosque – below) were the series of initiatives across the economies of the UAE to recycle petrodollars into critical infrastructure – and not just roads and airports but healthcare and education. And it is this opportunity where some of the greatest intellectual centers of the US can most effectively “export” their assets; while India and Pakistan and other developing countries provide much of the labor to build this infrastructure, it is the doctors from Cleveland who staff the new Cleveland Clinic hospital in Abu Dhabi, the faculty from NYU who teach at the new (controversial) campus in Abu Dhabi, the curators from New York City who run the new Guggenheim Museum who bring these institutions to life.

Sheikh Zayed Grand Mosque

This investment of petro-wealth has had a dramatic and obvious impact on society in the UAE…

  • Notwithstanding that there are less than one million Emiratis, supported by nearly 8 million foreigners, the UAE is home to two global airlines – Emirates and Etihad – and the most spectacular airports – all contained in 1,600 square miles
  • Life expectancy was 45 years in 1960 yet is now over 75 years as a result of significant investment in healthcare; literacy rates over that same period rose from 10% to virtually 100%
  • The UAE ranks as the 30th largest economy (with only 9 million people) and has a GDP per capita of around $49,000
  • There are thought to be 25,000 UAE students in the US, which is now back to pre-9/11 levels
  • UAE has the only peaceful nuclear energy facility in the region as well as the largest solar power plant in the world and with oil production of 2.8 million daily barrels which is forecasted to be 3.5 million in five years (for Emiratis the cost of oil is less than $5/barrel while the US is now paying well over $100/barrel, and so long as oil stays above $80/barrel, Emiratis will not pay taxes, get free healthcare and education – pretty good deal)
  • And to secure all of that the US has around 3,000 troops deployed in region

In addition to meeting executives from the technology and defense sectors, I spent most of my time meeting with investors and visiting leading healthcare centers. There are nearly 20 significant investment funds in the UAE with accumulated capital anywhere from $2.5 – $4 trillion depending on which analyst you believe. Many of these funds have identified healthcare as an important and emerging area of focus. Often partnering with the best global healthcare brands, the UAE aspires to be a leading regional healthcare provider given it is no more than a six hour plane flight from 2.4 billion people (the Arab World alone has 350 million people). Although much of the public health focus is on preventive diseases, there is now a goal to provide genetic screening for all newborns which is consistent with a significant regional genomics initiative. The developed world has exquisitely exported its bad health to this region as diabetes and heart disease are near-epidemic. A small sampling of how topical health issues have become were reflected in the lead stories in Gulf News on June 4, 2014:

  • “Draft Law on Contagious Diseases Passed” – authorities have new powers to quarantine people
  • “Call to Reform Health Care in Northern Emirates” – senior government official blasted Ministry of Health for lack of healthcare standards and shortage of doctors
  • “Dubai Health Care Sector to Grow Further” – notwithstanding 56% hospital bed occupancy rates, rising demand increased number of beds 9.2% in 2012
  • “MERS has Infected 68 and Killed 10 Since March 2013” – pretty self-explanatory

And that was just on June 4. The day before readers were treated to articles on the lack of adequate food safety and learned that the cold storage infrastructure is 40 years out of date, as well as provided coverage of improved cancer screening techniques. That day we also learned that women’s labor participation rate stood at 26% of those women who wanted to work (unemployment is ~40% across Middle East) although the headlines on June 2 screamed “No Limits to What UAE Women Can Achieve.”

The most extraordinary healthcare facility in Abu Dhabi has to be the new Cleveland Clinic facility which is slated to open March 2015 – an absolute marvel which will profoundly change care delivery throughout the region. While there I also met with a senior executive from Al Noor Hospitals Group, a small portfolio of hospitals in Abu Dhabi, which is now a public company with a market capitalization approaching $2 billion (2013 revenues ~$375 million). And a fascinating juxtaposition is the New England Center for Children – Abu Dhabi, which is equally extraordinary but for very different reasons. Opened in 2007, the Center leverages the nearly 40 years of expert autism research and education conducted outside of Boston to provide tremendous behavioral care for over 110 autistic children in the UAE.

And on the heels of those visits, I visited DuBioTech which is building the premier life science cluster in the Middle East. Founded in 2005, and modeled on important elements of the Singapore success story, there are now 154 life science companies partnered across 250,000 square feet of lab space operating in this tax free zone. And if that was not enough, an impressive educational center called Masdar Institute of Science and Technology, which opened in 2010, houses a microscopy suite (among many many other things) which rivals what one might see at MIT or Stanford and is now being leveraged across a series of commercial partnerships in region.

My friends at The Abraaj Group, a very successful private equity investor managing $7.5 billion focused on UAE, Africa and Southeast Asia, have made a number of healthcare investments – almost 20% of their diversified funds. And some of their most notable transactions involve novel healthcare delivery models, and in fact this past week announced an investment in Polyclinique Taoufik, a state-of-the-art hospital in Tunisia. As they shared with me, healthcare in the region is incredibly resilient with massive pent-up demand for quality services.

Coincidentally while in Dubai, which was wildly over-leveraged in 2008 and suffered significant losses during the Great Recession and has since been quite inwardly focused, the Arabnet Digital Summit was being held which brought together tech start-up’s from across the region. Much of the lamenting centered on the ever-present “funding gap” – not unlike what entrepreneurs suffer from in other parts of the world. But what is particularly unique to the UAE now is the dramatic volatility of the local stock exchanges – in part due the obvious geo-political issues but also the concerns around an imminent correction in the real-estate and construction industries; the Dubai Financial Market Index is off nearly 20% since highs reached just a few months ago, but is nonetheless up 39% year-to-date. Interestingly, according to A.T. Kearney, the UAE was ranked 11th globally in the Foreign Direct Investment Confidence Index, up from 15th in 2012 due to and I quote “developed investment opportunities, diversifying the industrial base and attracting innovative SME industries to the region.”

A job very well done – certainly given the neighborhood.

 

 

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VC in Search of the Promised Land – Literally…

The other day I drove from Israel to Jordan through the Jordan Valley which is 1,200 feet below sea level – and really hot. About an hour over the border (photo below) we stopped at Mount Nebo which is where Moses saw the Promised Land; below us was Jericho and on the distant horizon was Amman. I would like to point out that two weeks ago I would never have guessed that I would ever write those sentences.

Jordan Border

For the past ten days I have been traveling in the Middle East with Governor Deval Patrick of Massachusetts to support his trade mission to the region and to meet local entrepreneurs and investors.

Obviously the “Start Up Nation” phenomenon that is Israel is well chronicled. I was last there three years ago and the economic vitality and entrepreneurial success stories continue apace, even in spite of the Arab Spring which has upset all semblance of normal life in the region. There were over 500 attendees at an eHealth conference I spoke at – the size of the audience frankly caught everyone by surprise. The building boom in Herzliya, which actually seems sustainable, is testament to the power of their innovation economy.

But what I was really intrigued to see was how adjacent economies were faring with their interpretation of an innovation economy. Jordan signed a peace treaty with Israel in 1994 so notwithstanding long lines at the border crossing, the country has had 20 years of relative stability and valuable trade with its western neighbor – obviously complicated enormously by the influx of displaced Palestinians (coincidentally, while in Jordan, Hamas and Fatah announced the “Unity Cabinet” which generated sensational headlines in the local papers). And with this peace came a modicum of relative prosperity. A couple of other observations I would share:

  • There are thought to be 7 million inhabitants in Jordan but the make-up is tricky. In addition to the Palestinians, there are now 650,000 Syrian refugees – some analysts suggest that number may be well over 1 million. We saw United Nation Refugee tents along many of the highways; evidently they are sold on the black market as much of the population is still nomadic. While today only 1% of the country is Bedouin, that number had been 10% a generation ago and many more share that nomadic history and sensibilities.
  • There has been a significant investment made in higher education. We visited the King’s Academy, a high school modeled largely on Deerfield Academy with an extraordinary mosaic of students from around the world; other than the fact that it was nearly 100 degrees and there were palm trees, I could have been on any New England prep school campus (turns out the headmaster went to college with me – small world). Recently American and German universities were opened, which co-exist with a number of elite state universities. One gets the distinct sense that the commitment to education will lead to interesting clusters of economic activity.
  • And in fact there is now a real incubator in Jordan called Oasis500. In 1999 there was effectively no IT industry in Jordan; today IT represents 12% of the economy. Apparently 75% of all Arabic content on the Web is created in Jordan (although I am not sure how one would even go about determining that)
  • Jordan is the regional destination for medical tourism, at least for those in the Middle East who cannot afford to fly to Boston, New York, Cleveland, London, Paris, etc. We heard a lot about the investments being made in community hospitals – delivering quality healthcare to that population is complex.

So while our drive from Jerusalem to Amman presented to us a country haltingly on the road to continued improvement and prosperity, certainly as compared to its neighbors to the east/north/south, lunch with US Ambassador Jones (a brilliant foreign policy expert, who upon Senate confirmation is to be posted to Iraq) was a reminder how tenuous life still is there. The conversation was far-reaching but underscored that formal country borders are often incidental to cultural and tribal boundaries. In particular, the discussion of Kurdistan highlighted the profound disruption created by ancestral disputes. Seemingly Jordan has learned well that investment in its people through improved education and healthcare infrastructure leads to economic gains which drives stability.

Later that night I flew to Abu Dhabi – wow.

 

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VC Road Trip Across China

For much of the past week I had the distinct honor to travel across China (Beijing, Xi’an, Suzhou, Guangzhou, and Hong Kong) as a guest of one of the leading foundations and investment firms in country as they introduced a number of their exciting portfolio companies to the local investment community. Notwithstanding significant issues facing the country – environmental concerns, restive political tensions in some of the western provinces, bad debt from the “shadow banking” system, potential real estate “bubble” – one is struck by the deliberate and coordinated efforts to solve these problems, much of it through reforms recently introduced by the third plenum of the 18th Communist Party of China Central Committee; some of the reforms are quite forward-thinking I might add.

And what an extraordinary week to be in China: Alibaba is poised to go public (rumored to be raising at least $15 billion at a $200 billion valuation), JD.com did go public (raised $1.8 billion at a $25 billion valuation), Comrade Putin was in town signing historic business deals (49 deals after 10 years of negotiations), and the US Department of Justice decided to go after five Chinese military officers for stealing trade secrets, further distancing the two countries – at the exact wrong time.

Whenever I find myself in foreign countries I make it a point to read the local papers – this past week a number of fascinating articles jumped out at me in the China Daily. First to the business section: in isolation any of these items would be of limited interest but when looked at collectively – and in light of where China has come from – an extraordinary pattern emerges.

  • China Securities Regulatory Commission anticipates at least 100 IPO’s of A Shares in 2014; there were 43 IPO’s in January 2014 alone although only 5 since then.
  • This after a 14-month suspension of IPO activity while new rules were drafted.
  • There are 358 companies in registration, preparing to go public.
  • A May 19 China Daily editorial applauded the pending Alibaba IPO stating “the merchant rating system has evolved outside of the realm of government interference…provides shoppers a sense of democracy and self-management on an everyday level.” WOW.
  • In 1Q14 Chinese VC firms raised $1.07 billion, which is a 35% increase from 1Q13.
  • And on May 20 the Ministry of Finance in China announced that 10 provinces and cities will now be allowed to issue local municipal bonds. Think about that – independently financed cities – quite a departure from a centrally planned government.

Financial liberalization appears to be in part a response to the looming “shadow banking” crisis which analysts estimate to be as much as $2.9 trillion of local borrowings not officially recorded. To put that in proper context that would be twice the disclosed debt of the central government. Undoubtedly this has also contributed to a dangerous speculative real estate “bubble” which seems to be deflating quite rapidly now – real estate is estimated to be 15% of China’s GDP so this is a non-trivial issue. Importantly though, over time these steps should create a more robust and sophisticated capital markets ecosystem to fund future innovation which is now evident all across the country.

The other area of concern and at the top of the government’s agenda is the state of the environment. It is quite apparent that the authorities are very focused on this as poor environmental conditions, coupled with the associated impact on health, risks leading to significant social unrest. Many articles last week highlighted steps being taken to address the staggering environmental concerns.

  • With great pride, the local Beijing government announced that 288 companies were relocated out of the city in 2013, resulting in 7,000 fewer tons of sulfur in the air. Between now and October 2014 there are another 300 companies slated to leave.
  • In April 2014 air quality “improved” from prior periods as 70.6% of the time the national air quality standards in the top 74 cities were met and for 29 fortunate cities, the standard was met 80+% of the time.
  • The critical air quality metric is the “PM2.5” which measures the amount of particles less than 2.5 microns which happens to be the size that particles can penetrate the lungs – unfortunately recent measurements were 156% of safety levels in Beijing.
  • China has 20% of the world’s population but only 9% of the arable land which is driving great innovation in the food industry.
  • With a much greater commitment to public transportation, it was announced this week that there were 2.9 billion subway rides in Beijing last year (or 7.9 million each day!).

Interestingly, and perhaps not surprisingly, according to something called the Bureau of Exit and Entry Administration of the Ministry of Public Security over 26.3 million people visited China in 2013. The vibrancy and rapid economic growth in China are attracting people from around the world, and yet even China is struggling to attract highly trained talent as its economy matures. The authors of “The Fourth Revolution: The Global Race to Reinvent the State” (John Micklethwait, Adrian Woolridge) noted that as carefully as China has reinterpreted capitalism, it is now recasting the role of central government – which is evident in everyday life in China. The authors go on to observe that Chinese leadership looks to Silicon Valley and Route 128 instead of Washington DC for inspiration and insights. Quite a troubling commentary on the US, frankly. It used to be that the US system of government was the envy of the developing world.

An interesting juxtaposition for me was seeing the Terracotta Warriors in Xi’an, which arguably is one of the greatest archaeological finds in modern times. Assembled nearly 2,500 years ago, the 8,000 terra cotta statues are arrayed to protect the tomb of Emperor Qinshihuang. What an extraordinary display of central planning.

Terracotta Warriors

And as I listened to a number of US and Israeli entrepreneurs pitching their disruptive new technologies across China last week I was struck by the level of directed coordination focused on solving profoundly important financial and societal issues. Each of these entrepreneurs – brilliant, passionate, driven – had developed solutions to many of the problems confronting the Chinese today. And in China they found an incredibly engaged audience. The rest of the world should take note.

 

 

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What Just Happened?

The National Venture Capital Association recently released data on 1Q14 investment activity, which always makes for an interesting read – at least on long plane rides. Point of fact, this past quarter was exceptional in many ways – and arguably somewhat unexpected. The headlines read that $9.5 billion was invested in 951 companies, an amount we have not seen since the fateful quarter of 2Q01. But it is what is beneath the headlines, buried in the reams of data, which paints a more nuanced picture.

Undoubtedly the level of investment over the first 90 days of 2014 was unprecedented. In 4Q13 and 1Q13 the amounts were $8.4 billion in 1,112 companies and $6.0 billion in 916 companies, respectively. Clearly the stepped up investment pace throughout 2013 extended into 2014 – and tracked the increased liquidity VC’s witnessed along the way. Given the marked public stock market volatility which set in this past February it would not be surprising to see activity tempered over the next few quarters, suggesting that we probably are not on an annual investment pace of ~$38 billion for 2014 (4 x $9.5 billion); for context annual investment activity from 2011 – 2013 averaged ~$28 billion.

Overall certain important themes are emerging in 1Q14 data – VC’s are clearly investing in later stage companies, VC’s are investing in businesses that have meaningfully less technology and development risk, and round sizes have spiked, most notably by “mega rounds” of hundreds of millions of dollars – which probably skews the data somewhat.

So what jumped out at me?

  • Dramatic decline in Seed investing: only $125 million was invested in 41 seeds (average size $3.0 million) in 1Q14 as compared to $347 million in 69 companies (average size $5.0 million) in the prior quarter, which is a decrease of 64%. The advent of the micro-VC and “super angel” investor from a few years ago may be running its course.
  • Where did the Seeds go: Early round financings were $2.9 billion (451 companies, average size $6.4 million) of the activity which is a meaningful step up from 1Q13 of $1.6 billion (420 companies, average size $3.7 million). Not surprisingly many of the Seeds from prior periods have graduated onto the next phase of growth.
  • Expansion stage financings really spiked up: in 1Q14 $3.9 billion was invested in 274 companies (average size $14.3 million) which was over 40% of all investment activity for the quarter, as compared to $2.1 billion in 239 companies (average size $8.6 million) in 1Q13. Quite clearly VC’s are doubling down and supporting those Seeds which appear to be breaking out with larger rounds.
  • The Software category sucked the air out of the room: Software was 42% of all financing activity and by far and away the largest of the 17 categories tracked. In 1Q14 $4.0 billion was invested in 414 Software companies (average size $9.7 million) as compared to $2.3 billion in 361 companies in 1Q13. Arguably this activity came at the expense of other categories such as Telecom, Semiconductor, Networking and Equipment, Electronics which barely registered this past quarter (only $20 million was invested in Networking and Equipment for instance).
  • Services investing surged in 1Q14: all categories of Services (Business, IT, Financial, Consumer) more than doubled from 1Q13 and was $1.7 billion in 126 companies (average size $13.4 million). This is somewhat surprising given the historic VC aversion to services business models as they “don’t scale” and have lower gross margins. Are VC’s investing in safer companies? Clearly they have all but avoided capital intensive hardware businesses.
  • Healthcare held its own: in 1Q14 $1.7 billion was invested in 182 companies as compared to $1.5 billion in 182 companies and $1.9 billion in 252 companies in 1Q13 and 4Q13, respectively. Overall, though, healthcare (Biotech, Medical Devices, Healthcare Services) captured only 15% of all dollars invested.
  • Which category was the dark horse: over $250 million was invested in Retailing this past quarter as compared to $17 million in 1Q13!

The shuffling between stage of investing and industry categories is always illuminating. VC’s seem to be investing later to get closer to liquidity, perhaps to bolster their own fundraising stories as they set out to raise the new funds, but to also exploit the robust public capital markets. Arguably the rotation among industry categories reflects prior investment performance by category. Hardware centric businesses and those with long product development cycles have chronically disappointed investors; where would Biotech be right now were it not for the “biotech bubble” we witnessed over the past six months.

The other barometer of risk taking is “First Time Financings” which tracks companies receiving venture capital for the first time; some interesting developments jump out of those data:

  • First Time Financings in 1Q14 totaled $1.2 billion or 13% of all investment activity, which compares (poorly) to 21% and 19% in 1Q13 and 4Q14, respectively.
  • Early stage First Time Financings was $830 million of that activity, which was down slightly from $887 million in 1Q14, although Expansion stage showed a more marked decline to $135 million from $227 million in the prior quarter.

And I always get a kick out of some of the other data buried in the report…

  • 23 states had 3 or fewer venture investments in 1Q14. In fact 7 states had zero.
  • California captured $5.5 billion of the $9.5 billion invested which was up substantially as a percent of total dollars invested from 1Q13: 58% now as compared to 48% from a year ago. Further concentration of activity – although for those of us not in California it is important to note it is a huge state!
  • Hawaii, on the other hand, had 2 venture-backed investments which raised in total $271,000! How cute.
  • The Top 10 venture investment rounds in 1Q14 were at least $100 million in size (are those venture deals, really?) with Dropbox raising $325 million registering as the largest. And there were no healthcare companies on this list. These mega-rounds reflect funds with either too much capital or a strategy to anoint winners and thereby chilling any competitive companies being launched – but will they drive great returns – stay tuned.

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Let the Good Times Roll?

Earlier this week the National Venture Capital Association (NVCA) released the VC Quarterly Fundraising data for 1Q14. The expectation was for this past quarter to be a strong quarter for fundraising, given the (until recently) buoyant public equity markets and strong M&A environment which drove a lot of liquidity back to LP’s. But the headline number was quite a bit greater than many expected. Notwithstanding what investors might say, the level of fundraising is arguably a function of recent market action and investor sentiment – which is directly related to LP liquidity.

The headline for this past quarter was very positive – 58 funds raised an aggregate of $8.9 billion, which blew away 4Q13 of 53 funds and $4.9 billion raised. In all of 2013, 191 funds raised $16.9 billion which was consistent with the prior five years where plus or minus 175 funds were raising between $15 – $20 billion each year. But I am not sure one should now conclude that annualizing 1Q14 performance (where 230 funds will raise $35 billion!) is what to expect for this year.

Since 2008 the VC industry has been investing more capital than it has been able to raise in new funds. I have been worried that this dynamic will end abruptly (i.e., badly) as one would logically conclude the investment pace needs to dramatically slow as firms invest the balance of their funds. Or fundraising would increase materially. This imbalance is not sustainable. Notably we also learned this week that VC’s invested $10.7 billion in 1Q14, yet again exceeding how much was raised (the aforementioned $8.9 billion) – but at least the gap may be narrowing.

 

VC Fundraising

 

It is still a challenging environment for VC’s to raise new funds. As one stares at the data it is quite evident that the bifurcation of the VC industry continues apace – are we seeing the advent of only two predominant VC models: the “billion dollar firm” which is frankly focused on both a large number of investments and larger size investments and the smaller, more narrowly focused venture firm?

Some of those details buried in the data may provide insight into what is a more nuanced picture of 14Q14 fundraising activity…

  • Of the 58 funds raised this past quarter, four were greater than $1.0 billion in size.
  • This past quarter witnessed 33 funds raised by firms that had already raised a prior fund so therefore 25 funds were raised by “first time” firms – a nice indicator that the VC industry continues to be able to re-invent itself to some meaningful degree.
  • The largest of the new firms was $243 million
  • The top 5 funds raised $5.4 billion or 60% of all capital raised even though they represent just 8% of the firms which raised capital – continued concentration at the high end.
  • That phenomenon is even more acute when looking at the top 10 firms which raised $7.3 billion of the $8.9 billion (82% of the dollars) yet were only 17% of the firms – perhaps more troublesome for entrepreneurs staring at fewer larger firms as possible partners.
  • Of the 58 funds raised, 44 were less than $100 million in size – the average size of fund in this cohort was $27.5 million.
  • Let’s look at the other end of the market: 26 of the 58 firms raised funds were less than $10 million in size – ouch.
  • The bottom 10 funds totaled $8.4 million – yes, that is millions – so 17% of the firms which raised capital last quarter represented 0.09% of all the capital raised.
  • The largest fund raised ($1.38 billion) is 164x the ten smallest funds combined.

Does this mean anything really? Maybe not. Many of us are just thrilled that the VC industry seems to be able to once again raise capital, but what form this recovery takes will have significant implications for how we finance innovation. One question I wrestle with – is this concentration of capital leading to these multi-hundred million dollar “venture” rounds we are now seeing so routinely? Is that good?

An addendum: just announced – in 1Q14 all private equity firms raised $95 billion to put this into context…more than 10x that for venture firms.

 

 

 

 

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