Rock The House…From Silicon Valley to China

It’s that time of the quarter when venture capital fundraising data are released by the National Venture Capital Association (NVCA), possibly leaving all the sophisticated investors across the industry wringing their collective hands about frothiness. The latest data shows that VC’s in 2Q15 raised over $10.4 billion (slightly revised upward from the announced amount last week) across 74 funds – this is a 39% step-up from the amount raised in 1Q15 and a 27% increase from 2Q14. This is the largest amount raised since 4Q07 – do you remember what happened in 2008? Wow.

As usual the headlines tend to mask some important developments one sees when wading through the data. The VC industry continues to consolidate around a limited number of managers who raise large funds with large Roman numerals attached to them. There continues to be evidence that Limited Partners will occasionally support smaller, very focused funds but the land of mid-sized funds continues to shrink; only 9 of the 74 funds were between $100 – $300 million in size (disclosure: my firm – Flare Capital Partners – announced this quarter a $200 million fund which we believe is ideally suited to focus intensely on early stage opportunities, yet be “life cycle” investors and support our entrepreneurs across every round).

On a trailing quarter annualized basis the VC industry is tracking to raise $40 billion this year, which would be the most raised in nearly 15 years. Related, announced this morning were the VC investment data which show that VC’s invested $17.5 billion in 2Q15, implying an annual investment pace of nearly $70 billion. This $30 billion projected “funding gap” for 2015 is largely filled by non-VC investors (hedge funds, corporates, sovereign wealth funds, mutual funds) who arguably are looking for greater returns than what is available elsewhere in other asset classes. The question this begs is how will these investors behave when the tide inevitably turns. The other concern imbedded in all of this is one of absorption – that is, can the VC industry “productively” deploy $40 billion across 4,000 +/- companies this year? As of the end of 2014, the NVCA estimated that the U.S. VC industry to be ~$160 billion of assets under management which is meaningfully smaller than the $200 billion average size over the last 15 years. Given many firms could not raise funds during the recession, and those firms that could raise funds tended to raise smaller funds, the VC industry naturally shrunk; the concern now is that it might expand too rapidly.

2Q15 Funding Gap

Now for some interesting nuggets in the detailed fundraising data…

  • Of the 74 funds raised, 31 were considered “new funds” but they only raised $1.3 billion or 13% of the total yet they were 42% of the firms
  • Average size of “new fund” raised is $43 million which is overshadowed by the average size of the “follow-on” funds raised of $212 million – clearly success begets success
  • The largest “new fund” raised was $250 million by Geodesic Capital (congrats) while New Enterprise Associates raised the largest overall fund of $2.8 billion (not counting a separate $350 million side-car fund) – so Limited Partners will dabble with new managers but just not too much
  • The Top Ten funds raised $7.2 billion or 70% of the capital in 2Q15
  • The Bottom Ten raised $14.3 million or 0.14% of the capital – not a typo
  • 7 of the Top Ten funds are based in California and represent $6.3 billion
  • In fact, overall, California funds account for $7.7 billion or 74% of capital raised
  • And while 18 states were represented on the list, outside of California, Massachusetts and New York, fund managers in those other 15 states raised just $1.1 billion or 11% of the capital

California, specifically Silicon Valley, always leads where venture capital dollars are invested – typically ~60% of all dollars are invested each year in California-based companies. What is notable here is the extreme level of concentration of the underlying fund managers. When so much of the capital is managed in a single geography are we at risk of creating an “echo chamber” which drives herd/irrational behavior? Does this naturally lead to the overfunding of new categories as each firm wants its own portfolio company in a given category?

And as a point of comparison, given that I grew up in Hong Kong and remain fascinated about the emerging capital markets in China, that market always provide a provocative juxtaposition. The last few years have ushered in extraordinary change in China: the capital flows are staggering and now so is the volatility and issues of absorption. Some interesting – almost unbelievable data – coming out of China this past quarter…

  • 4,000 new hedge funds were launched in 2Q15, mostly focused on equity investments, funded principally by the emerging class of 90 million new retail/individual investors in China
  • There are now 12,285 hedge funds in China employing 199,000 people according to the China securities regulatory authorities
  • Year-to-date 2015, $452 billion of public and private equity – that is billion with a “b” – was raised in China according to J Capital Research
  • There is estimated to be $320 billion of short-term margin loans outstanding; these typically have a 6-month duration, with much of them held by these new retail investors – with these loans coming due, the recent volatility in the Chinese stock exchanges starts to make more sense. Citigroup estimated that some $4 trillion of equity valued was lost – this is twice the size of India’s economy
  • That is nothing though – $8.5 trillion of debt has been issued in China year-to-date and when combined with the $1.1 trillion of corporate bonds issued, this brings the total China debt load to over $28 trillion

Now that will be fun to watch play out…

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