So here is my obligatory post on Facebook…which will be the most spectacular IPO of a venture-backed company in the history of mankind…and it just priced tonight.
The shares priced at $38 giving the company a market cap of $104BN fully diluted, raising $16BN in proceeds. Of the 421MM shares being sold, 57% (or 241MM shares) are being sold by insiders; in the past few years only LinkedIn and Pandora had a higher percentage of shares coming from insiders. Assuming the “green shoe” over-allotment option is exercised, the total amount of proceeds will exceed $18.4BN. And this is where I want to focus.
Putting aside the potential negative signaling of all this insider selling (and General Motor’s voting with their feet (or tires) this week), what is the impact on the VC industry with all this liquidity? First – according to Fortune – some of the numbers:
- Individual shareholders (mostly Zuckerberg) are selling $3.2BN of stock and will retain stock worth $27.7BN
- Institutional shareholders are selling $8.3BN of stock and will still hold $15.8BN
- This does not include the existing institutional investors (T. Rowe Price, Andreessen Horowitz) which hold about $1BN of stock and are not selling, nor does it include all the other employees who are now fabulously wealthy
- Of the institutional investors, $5.1BN of stock being sold is held by institutions which have traditional LP’s and/or are themselves LP’s. This same group of investors will still have $10.6BN of Facebook stock yet to be sold.
For me what is most interesting is to speculate about what is to become of all this liquidity. The venture industry has struggled mightily to raise capital; in the past few years the VC industry has raised between $12 to $15BN annually. As these proceeds are realized and distributed, do much of these dollars get recycled – that is, will underlying LP’s begin to increase their allocations to VC as they start to see Facebook distributions? The math suggests that one year’s worth of VC fundraising is now in around half dozen VC firms fortunate enough to have invested in Facebook!
Additionally, we are watching a very deep and wealthy pool of new angel investors get created and collectively they will play a powerful role in the next wave of great company formation. Much like the “PayPal Mafia” from the last decade which sponsored many of this cycle’s great companies, the Facebook Mafia should do the same over the course of the next decade. These individual investors themselves could become significant LP’s in many venture funds which, if that were to be the case, would further drive VC industry expansion.
Or is this just all wishful dreaming?
A few days ago I attended a wide-ranging set of discussions for Harvard Business School graduates regarding the state of the VC industry. The discussions covered issues from international developments in Asia to how best to structure models of innovation to LP perspectives. I furiously made notes and thought I might share some of the highlights.
VC Developments Overseas:
A decade or so ago there was enormous excitement about VC investing in Asia. We watched with great anticipation as US VC’s “exported” our industry overseas, investing aggressively in business models which had exploded on the scene here and were now being launched in India and China. This naturally led to the creation of strong local VC franchises in those markets. Arguably these markets came of age very quickly which caused some of the participants to express some words of caution.
- Many of the China investors felt that we are now in very uncertain times. The failure of a number of China IPO’s, the emerging waves of disclosure around fraud and accounting irregularities, and the every present trifecta of lack of property/human/intellectual property rights were underscored. True economic reform in China did not start until the late 1990’s – less than 15 years ago – when the banking system was reformed. Have expectations outrun realities?
- There are now over 4,000 RMB investment funds in China.
- “China is transitioning from a consumer of know-how to a producer of know-how.”
- One the largest PE investors in the world shared that returns in China have been less than expected, and at best in line with other markets – that was quite sobering to hear.
- Others observed that China is 17% of global GDP and “will become an asset class.”
- India, on the other hand, has over 500 angel networks, a national stock exchange which has been vibrant for the last 20 years, and has a proliferation of national incubation funds.
- Many of the India commentators were very complimentary of that country’s ability to aggregate numerous private sector initiatives, but worried that the bureaucrats making these allocation decisions were quite inexperienced.
- Interestingly, the largest biometric database – until recently – was the FBI’s database, estimated to number 60 to 100 million people; India launched a national effort a few years ago and now has logged 250 million people – going to 600 million people in 18 months! As someone who is fascinated about Big Data in the healthcare space, that holds extraordinary promise. It was also pointed out the North Korea has catalogued all 26 million of its citizens – probably little VC opportunity there!
There was an interesting discussion around models to drive innovation featuring NASA’s Tournament Lab program, which is a set of crowd sourced “contests” where the community at large is asked to solve problems NASA is grappling with (I wrote about NASA last year). This approach was juxtaposed with traditional approaches which include…
- Internal Development: one defines the problem, finds the right internal workers, creates an incentive structure, monitors outcomes and then PRAYS for performance, which is opposed to…
- Contest Model: one defines the problem, establishes evaluation criteria, sets the prize (often quite modest in the case of NASA), recruits problem solvers from the community and then PAYS for performance
Limited Partner Impressions:
The final set of discussions involved the LP’s – our customers. One of the largest state pension funds, which very publicly lowered its VC allocation targets in its portfolio model, observed that VC returns have “detracted from overall performance in all time periods” – that kind of stings! On the other hand, LP’s from leading academic endowments had the exact opposite conclusion and shared that “VC has been a great performer for the endowment.” So a couple of conclusions I left with…
- As an LP, if you can get access to any manager you want, one can construct a fabulous portfolio of VC managers. Today, where access is not a meaningful issue, LP’s would be wise to lean into VC.
- Large pension funds have hundreds of VC relationships, which by definition, will drive overall performance to be median – and median VC returns have been bad. Full stop.
- There was a strong sense that there will be increased dispersion of returns from the median going forward, which for the last decade or so have been compressed.
- Even though VC returns overall have been uninspiring that in no way is to suggest that there have not been some spectacular funds.
- There are over 40 sovereign wealth funds which manage ~$4 trillion of capital; two-thirds of which were founded in last ten years. There is an expectation that they may be increasingly an active force in the VC industry.
Two other random observations:
- Everyone was focused on the fact that the amount of capital to get to point of failure or point of acceleration in most VC-backed companies is now at an all time low, and this will further cause the VC industry to shrink as fund sizes will/can be smaller
- The recently released Midas List (top 100 VC’s) has 33 people who went to a school in Boston – but only 3 on the list currently reside in Boston. That is a problem given how much of the nation’s VC dollars are managed in Boston – and we remain the second largest innovation economy behind Silicon Valley.
“Big data, little data…” Sounds like a Dr. Seuss book. Hadoop…Splunk…sound like characters in one of his books. Data is everywhere. Given Big Data is all anyone can talk about today, I have spent the better part of the past year immersed in many forms of data, trying to sort out where we might consider investing.
At its core these platforms are attempting to make sense of unstructured, often times, machine generated data to provide unique actionable insights – and not just for the Head of the Analytics Department, but for all employees. The desire to re-use, share and store this unstructured data has opened up enormous market opportunities up and down the IT stack. My particular focus is around the applications which are creating “smart tools” to drive innovation in the enterprise – and it is clear that every market vertical will be impacted. My most recent investment is in the Big Data analytics space for health plans – and it is very cool – more to come.
The IT stack today involves the following hierarchy: collection > ingestion and storage > discovery and cleansing > integration > analysis > delivery. I am most focused on the right side of this equation (some of my partners have made some very compelling investments on the left side of that equation such as 10gen, Nasuni, Crashlytics, Tracelytics, InfoBright). Out of my exploration there have been a number of interesting insights and funny sound bites which inform some of our Big Data investment themes:
- Big Data will democratize the enterprise, that is, all employees will become analytics experts who will drive work flow and productivity improvements – move the battlefield to front line employees
- The “3 V’s” – velocity, variety and volume – are not going away, in fact they are only getting more severe
- Movement to real-time analytics from batch processing is very powerful particularly in industries which process transactions where insights can now be moved from post-pay to pre-pay and pre-settlement (so rather than detecting fraud after the fact, fraud can now be readily detected prior to the transaction)
- Real demand driven supply chains
- Real need to drive insights from legacy IT architectures, particularly in the small to medium end of the market, who will be reluctant to overall existing infrastructures
- Make Big Data small data or useable data through adaptive algorithms
- In early innings of hyper-targeting across every industry
- “Social sensing” will overhaul product development, stocking decisions, better forecasting and alerting, etc
- Love the comment that “we are not looking to build more dashboards, but instead, cockpits”
We will undoubtedly be more refined and precise over time in how we look at the Big Data investment opportunity set. As part of this evolution, Flybridge hosted a Big Data CEO dinner a few weeks ago in Boston to identify how best to galvanize the community and where the greatest opportunities lie. In addition to great wines, there was a lot of enthusiasm for the new tools and architectures which are coming into the market. A follow-up dinner is being planned for the near future to better frame the opportunities – I welcome any suggestions for that agenda.
For me right now I am fascinated by the Big Data opportunities across the healthcare delivery system; as the FDA has become prohibitively hostile towards therapeutics and medical device companies, healthcare analytics is an area where profound benefits will be derived. As I mentioned earlier, my most recent investment is an analytics company focused on health plans – and the insights they are already demonstrating have enormous cost and revenue impacts for every health plan. Stay tuned – more to come.
We have just wrapped up the National Venture Capital Association annual meeting in Santa Clara, and amidst the gloom, there are a number of bright spots and even compelling reasons to be excited again. Clearly one of the highlights of the last two days was hearing legendary VC – Arthur Rock – when receiving the Lifetime Achievement award say “Writing the check is easy; doesn’t take much ink…”
Any investor would be pleased to have invested in just one of Rock’s many successful portfolio companies (Intel, Apple, Fairchild Semiconductor, Teledyne, Scientific Data Systems, etc). Listening to Rock and his re-telling of the many great war stories of the early days of the VC industry highlighted some of the parallels to what we are once again (hopefully) seeing – great and hugely disruptive new companies, explosive markets being created in very short order, brilliant and passionate entrepreneurs out to change the world. And maybe a return to a smaller VC industry – Rock’s first fund was $5 million and he did not invest more than $300k in any one company!
All this was echoed in Frank Quattrone’s (Qatalyst) comments earlier in the program who reported that he had not seen such optimism in the capital markets since the mid to late ‘90’s – although he did tick off the obligatory concerns such as domestic housing, China mark-down’s, Europe, modest growth, etc. Quattrone also noted that over the last few years there has been on average $150-$200BN of tech M&A which he expected to continue through 2012. His optimism was founded on six important trends he sees in the market: (i) enterprise models trending towards vertical integration (ii) move from “over-provision” to the cloud (iii) desktop transition to mobile (iv) structured going to unstructured data (v) physical to now digital commerce, and (vi) search being replaced by social/mobile/local. Quattrone closed by predicting a meaningfully more robust IPO market which is already helping to drive private market valuations to levels not seen since the ‘90’s ( can you say Instagram?).
Other chatter in the hallways included:
- Pats on the back all around for the JOBS Act, favorable definition of what the VC industry is and isn’t for regulatory purposes, defeat of SOPA/PIPA
- This may be the most uncertain period in DC over the last 20 years and there is little to no expectation of meaningful regulatory advances through the end of the year
- SEC is very nervous about crowd funding as they are still trying to get their collective arms around the Dodd-Frank implications
- Tax reform debate in 2013 may take on eliminating any differential between capital gains and ordinary income rates, as well as challenge “pass through” entities (and impose corporate tax structures on them)
- Real crisis at FDA as they take on the reauthorization of “user fees” which apparently covers ~40% of the FDA’s annual budget. This all needs to be wrapped up before year-end or the FDA shuts down. All this urgency, optimists believe, may drive real FDA reform.
- Cumulative market capitalization of listed securities on NYSE (they were a sponsor) is $24 trillion dollars – much of which I am now convinced Arthur Rock is responsible for.
Yesterday the National Venture Capital Association (NVCA) – in conjunction with Thomson Reuters and PricewaterhouseCoopers – released 1Q12 funding data for the VC industry, and frankly the numbers are startling – but yet in some sense, upon reflection, not surprising. For the quarter there were 758 deals which raised $5.8BN, which was down 19% on a dollars basis and down 15% for deals from 4Q11. If you were wondering, these levels are down 13% (dollars) and 12% (deals) when compared to 1Q11.
The VC industry is contracting and consolidating swiftly, but oddly the amounts invested have been tracking meaningfully ahead of the dollars raised by VC firms. The graph below shows that the lines have been diverging for nearly four years – this won’t end well. Clearly the dramatic reduction in amounts invested in this past quarter suggest that the lines may now be starting to converge – at a minimum trending downwards and will probably settle at meaningfully reduced levels, perhaps as low as $12 – $15BN per year for both amounts raised and invested. Ironically they may still not converge as the VC industry struggles to raise capital.
As I studied the data this weekend I observed a number of other important themes which entrepreneurs should be mindful of as they consider raising capital.
- Even the Software category was soft in 1Q12 – $1.6BN across 231 deals which was down 18% in dollar terms from last quarter (average size ~$7MM per financing)
- Biotech took it on the chin – $780MM invested in 99 deals which is down 43% in dollar terms and down 14% in number of deals from last quarter (average size ~$7.9MM)
- Cleantech was not saved from the downdraft either – $951MM across 73 deals which was down 30% dollar terms and down 11% in number of deals from prior quarter
- Even Semi’s were not spared, down 43% in dollar terms quarter-over-quarter
Clearly as the VC’s invests fewer dollars in any given quarter, most categories will be down. What is most striking is the continued and strong rotation away from industries that have significant scientific and regulatory risks, and are also characterized by long times to generate investor returns. Notwithstanding popular opinion, VC’s aren’t dummies.
Other observations around stage are also notable.
- Late Stage investing was up 11% this quarter and represented 40% of all deals. Clearly there is a rotation to opportunities nearer to liquidity, which most funds need to show in order to raise new funds. There was $2.3BN invested in 208 Late Stage companies this past quarter which was consistent with the $2.4BN and 234 deals in 1Q11.
- “End of the Great Seed Experiment” which is something I have been saying for the better part of a year – there was only $141MM invested in 53 deals in 1Q12 (admittedly I think that number is under-reported) as compared to $156MM and 90 deals in 4Q11 and strikingly to the $211MM and 86 deals in 1Q11. I have been on this thread for some time; that is, the VC industry is at risk of having created too many “me too” companies, and with less capital to invest across the board, many seed entrepreneurs will be deeply saddened when they come back to market for their Early round…
- Softness in Early rounds – $1.6BN was invested in 290 companies which were materially down from $2.3BN and 382 deals in 4Q11 (and somewhat so from 1Q11 – $1.8BN and 320 deals). VC’s over the last few quarters went very early (how many “seed programs” were started?!?) and now they are going later to either support existing portfolio companies or buying pre-liquidity companies.
The geography debate also grinds on with some surprising data in 1Q12. Of course the Valley still dominated – not newsworthy – but there was some hint of re-ordering of the silver and bronze winners.
- The Valley saw $2.1BN invested (36% of national total) in 213 deals (28% of total) which is interesting when you see that California in total was $3BN in 294 deals. Interestingly in 4Q11 the Valley witnessed $3.3BN (46% of total) in 289 deals (and $2.7BN in 251 deals in 1Q11). Surprised by the “percent of total” data, which probably bears watching more closely.
- Massachusetts had $628MM invested in 90 companies as compared to $678MM in 97 deals in all of New England. The data for Massachusetts in 4Q11 was $757MM in 92 deals, so some meaningful deterioration quarter-over-quarter, but not as severe when looking at 1Q11 data of $670MM in 86 deals.
- And so how did New York do? In 1Q12 the New York Metro area saw $378MM invested in 75 deals (New York State was $271MM in 62 deals), which is less than both Massachusetts and New England – interesting. In fact New York Metro was less than Texas. The NY Metro region had $576MM in 84 deals in 4Q11, so there was quite a drop heading into 2012 (for 1Q11 the numbers were $586MM and 82 deals). That is very surprising to me.
- Lastly, and this one always amuses me, 11 states in the country had zero – nada – VC deals, while 19 had less than 3 deals in 1Q12. Are 60% of the states not even in the innovation economy?!?
While there were a lot of important topics addressed at the recent National Venture Capital Association board meeting in DC, the central item involved the recently passed JOBS (Jumpstart Our Business Startups) act by the Senate and supported by the Obama Administration and is now before the House. The act, which is strongly supported by the Republican leadership in the House, is bundled with a series of other important capital formation bills.
Some of the other topics we reviewed were:
- Crowd funding: seems to be an emerging reality that legislators are quickly going to school on. While there are concerns about potential abuses, a company’s ability to sell a modest amount of stock without registering but using trusted (i.e., regulated) intermediaries appears to be gaining wide support. Can eBay be used to facilitate this?
- Tax reform: notwithstanding the rhetoric around carried interest, and Romney’s tax returns, there is a sense that no real effort will be made to modify existing tax code before the national elections this fall.
- Cleantech: there does not appear to be real support now for new cleantech initiatives. The opposition of the utilities industry appears to have stifled any new regulations. Notably we learned of a mock cyber-attack on the power grid in early March – will be interesting to hear of their findings.
- Life sciences: there seems to be considerable government interest in crafting a set of new user fees which will be placed on life science companies. As if things weren’t tough enough…
- Accounting: for those CFO’s out there, it appears that the SEC will accept the International Accounting Standards board recommendations and that the US will move to be more in line with international jurisdictions. Additionally, and this is good news, the Financial Accounting Foundation (which oversees FASB but reports to the SEC) is preparing to make concessions for non-public companies by providing relief from needlessly burdensome accounting provisions.
As we were wrapping up the board meeting, we discussed the fall general election. Two interesting – non-scientific, non-authoritative – observations were made:
- If Obama wins, the Republicans will most like hold the House and take back the Senate, in which case absolutely nothing will get done for the next four years, or,
- If Romney wins, shortly into his administration he will realize that the situation is worse than he expected and he will (ironically) have to raise taxes.
On the eve of the historic Facebook IPO roadshow, I spent some time looking at the 4Q11 IPO data (courtesy of Campton Private Equity Advisors) this weekend. VC’s everywhere are hoping that Facebook will unleash of wave of public offerings and meaningfully improve investor sentiment towards venture-backed IPO’s. Arguably, though, Facebook is so unlike any other company sitting in VC portfolios that it may be hard to draw any immediate conclusions based on this IPO, which is why I was interested in looking at a broader cohort of recent IPO data to gauge where the market might be heading.
Somewhat surprisingly there were only 10 venture-backed IPO’s in 4Q11, led by Groupon and Zynga, which was double the number of IPO’s in 3Q11. For the entire year, there were 40 IPO’s which compared unfavorably to the 45 in 2010. The backlog at the end of 2011 was 57 venture-backed companies which compared nicely to the 44 and 28 at the end of 2010 and 2009, respectively. Unfortunately the average number of days in registration for these companies was 225; 8 companies have been waiting more than 365 days. Fifty of the 57 IPO’s in registration are raising between $50 – $150 million, only one is raising less than $50 million. The average amount of equity invested prior to IPO was $116 million.
More troublesome though was the post-IPO trading performance many of these 4Q11 offerings experienced. Three of these IPO’s are trading below the price they came out. Three of the 10 IPO’s in 4Q11 priced above their initial offering range, while four IPO’s priced below their initial range.
Here’s a bunch of other 4Q11 data:
- Average size of IPO was $256 million; Zynga was the largest at $1 billion
- Average IPO market cap was $2.5 billion; Groupon was the largest at $12.8 billion
- 50% of the IPO’s were in the IT sector, 20% were healthcare
- Median time of all 2011 IPO’s from initial equity funding was 6.4 years, an improvement from the 7.4 years for the class of 2010
- The average first day performance in 4Q11 was almost an increase of 16% although over the past 12 months, average IPO performance for all 2011 IPO’s was negative 6.4%
- Average revenue rate for 4Q11 IPO’s was $380 million; the median was $90 million (data skewed by the $1.7 billion revenue for Groupon)
- The enterprise value to revenue run rate multiple was 5.6x which makes the ~20x multiple for Facebook look very lofty indeed
- Only 4 of the 10 IPO’s in 4Q11 were profitable
- Average percentage of shares issued post-IPO was 19%, although Groupon was 5%
- Greylock had the most IPO’s in 4Q11 with 5
- Morgan Stanley was lead manager for 15 IPO’s last year; Goldman was second at 14, which was tied with J.P. Morgan
So what do I make of all these data? I think the IPO market is still pretty weak. The companies that are able to get public have raised nearly $120 million beforehand, are generating significant revenues, and still they sit in the queue for a long time, waiting for the IPO window to crack open. There are thousands of venture-backed companies launched every year and yet only 40 were able to go public last year. And even when they made it through that gauntlet, their stock prices tended to trade down.
The good news is that Facebook is unlike any other venture-backed company waiting to get public so none of these data matter.