Land of the Giants…

The 4Q14 venture industry fundraising data (compiled by the National Venture Capital Association) were just released which always makes me sit up straight and take notice – it’s kind of an industry scorecard. In addition to being baffled by the fact that the amount my industry invests chronically outstrips how much we raise (see below), I am intrigued by the other forces at work as the VC industry risks behaving more like a money management business. But first the facts…

Last quarter nearly $5.6 billion was raised by 75 funds, of which 27 were “first time” funds. While the number of funds raised was 14% ahead of 3Q14, the amount of dollars raised dropped 9% from 3Q14 (as compared to 4Q13 – a year ago – the number of funds was up 17% while the dollars raised was effectively flat). For all of 2014, $29.8 billion was raised by 254 funds, which effectively returns us to 2007 levels when $30 billion was raised. This compares to nearly $48.3 billion that VC’s invested in 2014 in 4,356 deals. The “funding gap” in 2014 of $18.5 billion is unprecedented – in fact if you lay out the data for the past 30 years (which I just did), up until 2002 the amounts raised vs. invested every year basically tracked each other; six years ago a persistent and growing “funding gap” started to emerge.

So either these lines will converge rapidly – that is VC’s simply shut off the investment spigot (which is easier than raising materially larger funds – more on that below) or there is a more profound evolution of the early stage capital marketplace. In an environment of basically free money and zero interest rates, Limited Partners are increasingly looking to the VC asset class to drive investment returns. Cambridge Associates just released its “Endowments Quarterly – Third Quarter 2014” report where the average US Endowment and Foundation universe in 3Q14 returned -1.3% (yes, negative 1.3%). Those with top quartile overall performance had the greatest PE/VC allocation which was 12.8% of all assets managed and generated 17.4% return for the 12 months through 3Q14. Notably the bottom quartile performers had only 2.4% PE/VC exposure. Notably – again – the US PE/VC index one-year return performance was 24.4% for the 12 months through 3Q14.

We know that capital follows returns but arguably something equally important is also occurring, and that is the dramatic rise of the secondary market. According to intermediary Setter Capital, total secondary volume in 2014 was $49.3 billion – an increase of 37% from 2013. As greater liquidity comes to this part of the capital markets, Limited Partners in VC funds increasingly have credible alternatives to sell a VC fund commitment, perhaps making it more of a “trading asset” or at least, create the appearance (illusion?) that these commitments are no longer 10+ years in duration. The Setter report observes that there are increasingly very large buyers coming into the market buying positions in a wide array of private investment vehicles such as real estate, PE, venture, hedge and infrastructure funds. In 2014 there were 1,270 transactions in the secondary market.

But neither of the above observations accounts for the entire “funding gap” – clearly the investment data are capturing non-VC investors. This is in part the “Uber phenomenon” where a venture-backed company raises billions of dollars and it all gets lumped into the venture category (last month, Uber raised ~$1.8 billion from the Qatar Investment Authority, Goldman Sachs, Baidu, assorted hedge funds). Clearly non-VC investors are looking for greater returns and have come down market to find them – either investing directly into portfolio companies or into venture funds – which in turns drives up the investment activity and pace (and valuations for break-out companies).

And as always there were some fascinating nuggets buried in the detailed fundraising data which serves to better clarify what may be really going on underneath the headlines…

• Of the 75 funds raised in 4Q14, the Top Five took home $2.3 billion or 41% of all dollars raised…the Top Ten scoped up $3.3 billion or 59%
• While the average fund size was $74 million, the median was a paltry $14.7 million…think about that long and hard
• So naturally I looked at the other end of the list – the Bottom Ten funds raised totaled $8.8 million or 0.15% of all dollars raised – not a typo
• One new fund was listed as having raised $40,000 – really?
• Of the 75 funds raised, 50 of them were less than $100 million in size – but it gets better
• 27 funds were less than $10 million in size
• Over the course of 2014, there were 96 first-time funds raised (of the 254 total new funds) – those first-time funds totaled $3 billion – so 10% of all dollars raised in 2014 was by nearly 40% of the funds (the largest first-time fund was Presidio Partners at $140 million – congrats)

Lost in all the news about domestic VC fundraising, two other important geographies were making their own noise. The State Council of China announced this month plans to establish a $6.5 billion fund to provide seed capital for start-up’s. According to Zero2IPO Capital, a PE investor in China, the estimated the size of China’s venture capital industry was $6.8 billion in the first half of 2014, so this is a potentially a big deal in China. And not to be left out, buried further in the announcement, China’s Insurance Regulatory Commission made clear that it would allow insurance companies to now invest in venture funds. And on the other side of the world, the Israel Venture Capital Research Center released its own 2014 data which showed that $914 million had been raised, which was an increase of 68% over 2013 levels. The largest Israeli fund was raised by Carmel Ventures at $194 million.