We have waited a long time for this to happen – the amounts of capital raised and invested by venture capitalists in a given quarter are now the same. For nearly a decade the total amount invested in venture-backed companies meaningfully exceeded the amount of capital raised by the venture industry. This “funding gap” was in large measure due to the participation on non-VC’s like hedge and mutual funds in later stage venture investments. Given the non-existent IPO market for “unicorns” and modest level of M&A activity, there appears to be evidence that those investors have started to seek returns elsewhere.
Somewhat confounding is the continued robust fundraising environment. But as with many things, there may be more than meets the eye here. According to the National Venture Capital Association, in 1Q16 the venture industry raised $12 billion across 57 funds, which with great fanfare was declared the largest quarterly amount raised in ten years when in 2Q06 the venture industry raised $14.3 billion. This past quarter’s activity was dramatically greater than the prior quarter when only $5.5 billion was raised by 51 firms and greater than the prior year’s first quarter (1Q15) when $7.5 billion was raised by 69 firms. What makes this quarter so remarkable is less the overall amount but the composition of the $12 billion; that is, the fact that 30% of the total amount raised was for just 3 funds underscores the continued concentration of capital with a limited number of firms. Couple of other fun fundraising facts:
- The top ten funds raised nearly $7.8 billion or 65% of the total
- While the average fund size was $210 million (completely misleading), the median was $65 million
- There were 14 first time funds which raised $894 million or 25% of the firms only raised 8% of the total
- The largest fund was raised by Founders Fund at $1.3 billion while the largest first time fund was raised by 1955 Capital with $200 million
- Of the 57 funds raised, 28 were in California while 11 were located in New York; only 3 were in Massachusetts which is surprising given the historically strong VC cluster in the Bay State
- Those top three states raised $11 billion of the $12 billion and averaged $263 million in size, while the 12 other states that raised funds secured only $1 billion which averaged $65 million in fund size
- There were 31 funds of less than $100 million in size and in total they accounted for $797 million or 7% of the total – all of those funds collectively were just slightly larger than the fourth largest fund raised in the quarter – significant bifurcation of managers
- And somewhat in disbelief, 14 of the funds raised were less than $10 million in size
And while it is dangerous to simply annualize a given quarter, the pace coming out of 1Q16 suggests that $48 billion will be raised in all of 2016, which would be nearly $20 billion more than 2015. Coincidentally – and finally – this is effectively the same amount that is on pace to be invested in 2016. In 1Q16 approximately $12.1 billion was invested in 969 companies, which is the same amount that was invested in 4Q15 although that was in 5% more deals. While this is the ninth consecutive quarter that more than $10 billion was invested, the amount invested clearly is now trending downwards; in all of 2015 nearly $59 billion was invested as compared to the pace suggested by 1Q16 results of just $48 billion for 2016.
The concentration phenomenon witnessed with capital raised by funds is even more acute when looking at where capital was invested. The top ten funded companies in 1Q16 received 25% of the capital. As in prior periods, the Software category captured the top spot for sectors given $5.1 billion was invested in 376 companies, which was 42% and 38% of the totals, respectively. Life Sciences, which includes Biotech and Medical Devices, secured $2.3 billion across 177 companies, which was effectively flat from the prior quarter. Consistent with the trend line from prior periods relatively more capital was invested in later stage companies. Together the number of Seed and Early deals was only 48% of the total which is down markedly from the 57% in 4Q15.
Interestingly, the impact of crowdfunding is starting to be felt, and for many entrepreneurs, these platforms are viable alternative sources of capital (in the form of early product orders). Since mid-2009, Kickstarter has raised $2.3 billion across nearly 104,000 projects, of which nearly $650 million was in 2015 alone, while Indiegogo has garnered $850 million since 2008. Analysts have estimated that 38% of all technology projects on Kickstarter were deemed “on-time” while 30% either were delayed or failed to deliver a product.
The healthcare technology sector saw continued significant investment activity. While the NVCA does not separately track this sector, StartUp Health does a very good job in cataloguing all of the transactions. Accordingly, in 1Q16 there was $1.8 billion invested in 100 healthcare technology companies, of which the top sub-sectors were Analytics, Medical Device, Patient Experience, Personalized Health and Wellness. Notably the number of deals was down from prior quarters, although the round sizes were larger possibly indicating a maturation and confidence in these companies as they raised significant amounts of expansion capital (and of course the $400 million Oscar financing arguably skews some of the data). The top ten healthcare technology companies raised over $1.1 billion or 63% of all funding.
Clearly the transformation of the business of healthcare is well underway, and where there is disruption, novel innovative companies will be created to drive that change. From regulatory reform to the aging population to the convergence of low cost, high power compute technologies which have led to better understanding of biological pathways and predictive/personalized care, all of these forces have conspired to draw entrepreneurs to the healthcare technology sector. Recently the IMS Institute for Healthcare Informatics calculated that Americans spent $310 billion on medications in 2015 – soon to be $610 billion in 2020 – which pointedly underscores the enormity of the opportunity – and challenge. According to the Robert Wood Johnson Foundation, the U.S. spends nearly $3 trillion on healthcare yet corporate America loses $226 billion each year due to sick and absent employees.
The other notable development in 1Q16 was the absolute lack of venture-backed IPOs. Of the eight IPOs this past quarter, which only raised $700 million, none were technology companies, much less unicorns (there were three “blank check” companies which will use IPO proceeds to make acquisitions). Interestingly, the companies that managed to get public were all early-stage healthcare companies, although in order to get public, there was significant insider (read, VC) support in the IPO, in many cases more than 40% of the offering was purchased by existing investors (in the case of Editas, 67%of the IPO was purchased by the insiders). Unfortunately, nine other companies pulled their IPOs while too many to count delayed their plans. This was the weakest IPO market in over six years or since the depths of the Great Recession. It also compares unfavorably to recent activity; $5.5 billion was raised by 34 companies in 4Q15 and an even more impressive $37.6 billion was raised in 3Q14. Year-to-date, the Renaissance IPO Index has generated a negative 8.0% return versus the S&P 500 which is essentially flat for the year.
The IPO “air pocket” for venture-backed tech companies may be best understood when looking at forward revenue multiples for publicly traded SaaS businesses. The apparent discount between high-priced private rounds and public market valuations certainly is playing a role in the IPO market shut down, but so is investor anxiety over the quality of earnings; the S&P 500 saw earnings decline 8.1% this past quarter and the forecast for the year has already been reduced by 15%. This lack of liquidity is even more confounding now that the Russell 1000 is trading at 17.9x forward earnings as compared to 16.5x two years ago. With public equity benchmarks now within a few percentage points of the all-time highs hit in mid-2015, one would logically expect robust IPO activity.
Conversely, at the very least, one would expect significant M&A activity, but there too, most of the action has been around smaller transactions (according to Dealogic there has been 2,800 transactions valued at less than $100 million). Year-to-date there has been $282 billion of announced M&A transactions but that is overshadowed by the $340 billion of abandoned deals, in part due to regulatory scrutiny. Private equity backed companies represented only $15.4 billion of that total volume across 125 transactions, although the leading sector with 17 announced deals was healthcare. Globally, there was only $44 billion of private equity backed M&A deals, down nearly 60% from the prior year period.
At least on April 24 we will all “celebrate” Tax Freedom Day which is the date when the country has earned enough income to cover all 2016 federal, state and local taxes.