Against a backdrop of unprecedented global capital flows, three themes emerged in 2017 that underscored a fairly dramatic evolution of the venture capital model: (i) continued globalization of the venture industry, (ii) further concentration of capital with fewer firms, fewer portfolio companies and (iii) advent of novel cryptocurrencies. And I am pretty sure that all of this drove up the price of Australian wool by nearly 60% over the past two years.
This past year was a watershed for the US venture industry as it represented less than half of global venture capital activity for the first time ever. Notwithstanding that, it was another robust year with over $84.2 billion invested in 8,076 companies according to National Venture Capital Association (NVCA) data. While the number of companies was the lowest annual level in five years, the dollars invested was the highest amount in nearly 20 years. Quite clearly, investors are supporting existing portfolio companies with larger financing rounds. The top ten financings this past quarter accounted for 26.3% of all dollars invested yet only 0.6% of all companies – further evidence of investors “supporting their winners.”
In fact, the number of seed and angle financings has dropped by nearly 2,000 companies annually since 2015 while the level of activity for early and late stage companies has stayed relatively constant. The median age of companies at each stage of financing is meaningfully older now, in part as a result of larger round sizes providing longer runways. The average early stage financing was $6 million, which was 20% greater than the level in 2016.
The life sciences sector saw an extraordinary amount of activity in 2017 which was at a ten-year high with $17.6 billion (21% of total) invested in 1,046 companies (13% of total), both underscoring the capital intensity of this sector but also the greater level of investor enthusiasm around personalized medicine and a more accommodating FDA.
Globalization of the venture capital model is awkwardly juxtaposed to an administration raising trade tariffs. While the flow of goods may be more constrained, the venture model has been successfully “exported” as more than half of all venture investments were made outside of the U.S. in 2017. According to Preqin, global venture activity was $182 billion in 2017 across 11,144 companies. Case in point: in 2017 over 271 billion yen ($2.6 billion) was invested in Japanese venture deals as compared to 64 billion yen ($600 million) in 2012, per Japan Venture Research. Corporate venture programs accounted for 26% of all activity last year in Japan, increasing to 70.9 billion yen ($670 million) from a mere 1.2 billion yen in 2011. As point of reference, Japanese companies have $940 billion of cash on their balance sheets.
An important barometer as to the overall health of the venture industry involves the level of IPO activity, which surprisingly continues to be quite modest in light of strong public equity markets. Notwithstanding that there were 24 venture-backed IPOs this past quarter (and 58 for all of 2017), which was the highest level in 10 quarters, analysts had expected greater IPO activity. Twenty-one “unicorns” (companies privately valued at over $1 billion) went public in 2017 versus only 10 in 2016. Notably, in the second half of 2017, “unicorns” collectively raised $26.7 billion in private capital, continuing to avoid the public markets. Of this amount, 91% was invested in “pre-existing unicorns” versus the 9% in “first-time unicorns.”
Overall venture-backed M&A exit activity was also disappointing, yet again. According to NVCA data, there were only 769 venture-backed exits for $51 billion in value. Distributions from venture funds to limited partners declined 12.9% in 2Q17 (the most recent quarter tracked by Cambridge Associates) which was the third lowest quarter in the last five years. The larger financings referenced above allows for companies to stay private longer.
The other closely watched indicator of the health of the venture market is the amount of capital raised by venture funds. In 2017, venture firms raised $32.4 billion over 209 funds (average fund size of $155 million), the lowest marks over the past four years. One might expect that as liquidity improves, venture firm’s fundraising pace will accelerate. The top ten funds accounted for nearly 75% of all capital raised yet was only 22% of the firms, rendering the average somewhat meaningless as the industry is characterized by larger multi-billion dollar, multi-sector funds that coexist with smaller specialized firms.
PricewaterhouseCoopers recently reported that frenzied fundraising activity will lead to a doubling of assets managed by all private equity, hedge funds and other alternative vehicles to $21 trillion by 2025 globally, of which $10.2 trillion will be in private equity; the $10.2 trillion is equivalent to 50% of the market capitalization of the New York Stock Exchange or 100% of all publicly traded stocks in China. Today there is $1.6 trillion of committed but uninvested capital, $1.0 trillion of which is private equity.
Bain estimated that there was $180 billion of “public-to-private” buyout activity in 2017, which was twice the 2016 level but still only around 40% of the highwater mark of 2006, which was the busiest year ever.
Can we talk about SoftBank, which touches both the globalization and concentration themes referenced at the outset? Many believe that SoftBank’s Vision Fund is wreaking havoc on both valuations and round size. Last week, DoorDash, which had set out to “only” raise a $200 million Series D, closed on $535 million from the Vision Fund. In 2017, the Vision Fund invested $37 billion in 40 companies (44% and 0.5% of 2017 U.S. totals, respectively). Since 1995, SoftBank has lead $145 billion of investments.
Over-funding companies risks being as dangerous as under-funding companies. There are a set of product, team and commercial milestones companies typically are expected to have achieved at each round of financing. This profile tends to frame the appropriate size of the subsequent round of financing. According to Silicon Valley Bank, which looked at data from 2011-2017, the median Series D financing is just under $14 million in size, which is 1/38th the size of the DoorDash round. We have clearly entered an era when capital is aggregated around a relatively small number of companies, invested by a relatively small number of firms.
Anyone with a pulse could not escape the third theme which was the explosion of cryptocurrencies. In 2017, there was $6.5 billion raised via Initial Coin Offerings (ICOs), much of that in 2H17. Notwithstanding last week’s issuance of dozens of subpoenas from the Securities and Exchange Commission and that Bitcoin has traded down 45% since its mid-December 2017 highs, there has been $1.7 billion raised in ICOs so far this year. This year 480 ICOs were launched, of which 126 closed at a median size of $12 million. Two of the ICOs – Telecom ($1.5 billion) and Block.one ($850 million) – captured most of the attention. Only four IPOs since the beginning of 2017 were larger than the Telecom ICO, which did not go unnoticed by the venture community.
Token Data tracks 902 ICOs and discovered that 142 of them failed before raising capital and another 276 failed after fundraising, for a failure rate of 46%. Less understood is what happened to another 113 ICOs that “semi-failed” and can no longer be found – they are AWOL, having ghosted their investors. Bitcoin.com determined that $233 million from ICOs were invested in projects that simply failed, while a recent MIT study estimated that there has been anywhere from $270 to $317 million of outright ICO fraud. In January 2018, the Japanese crypto exchange Coincheck was hacked for $500 million.
In other examples of the convergence of globalization and cryptocurrencies, Venezuela just launched its own state-sponsored cryptocurrency called the petro; evidently $735 million has already been sold. Go figure. Late in 2017, the People’s Bank of China shut down crypto exchanges and ICOs, given concerns over loss of state control. To all of this, Warren Buffet proclaimed last month that he would be pleased to buy put options on every flavor of cryptocurrencies out there.
Valuations are increasing everywhere you look. Even the price of a kilogram of Australian Merino wool is up nearly 60% in the last two years and now costs $14/kg. Between Australia and New Zealand, there are estimated to be 103.5 million sheep, which shockingly is nearly a 100-year low for the local sheep population. In fact, the ratio of sheep to people in New Zealand has dropped to 7:1 – it used to be 20:1 nearly 35 years ago. Given the good times, and the prevailing herd mentality (sorry), Australian wool analysts point to the fact that every venture capitalist now has added slick new Allbirds wool shoes to their uniforms (I have three pair) which is screwing up the pricing of wool.