Whoa Nelly – A Pullback on the Reins…

Maybe you thought that the investment pace was going to slow even faster than it did in this past quarter, which dropped nearly 20% when compared to 3Q16? Per the National Venture Capital Association, in partnership with PitchBook, 4Q16 marked the sixth consecutive quarterly decline in deal volume. What is perhaps more surprising was that the $12.7 billion invested last quarter was the lowest quarterly amount since the end of 2013.

Arguably this retrenchment reflects concerns about valuation levels and the lack of “unicorn liquidity” as many later stage companies stayed private and/or struggled, and crossover investors backed away from new commitments. In 2016, of the 111 IPOs, only 37 were venture-backed companies. The average offering size was only $71 million. Notwithstanding unprecedented public consternation surrounding the election, the public markets experienced rather modest volatility; in fact, the VIX (the CBOE Volatility Index) languished in the mid-teens for much of this past quarter while hovering in the mid-20’s over the summer, post-Brexit.


With near historic low levels of unemployment and quite compelling GDP growth, the tightening monetary policy positions of the new administration suggest that bond yields will increase in the face of modestly higher inflation. GDP growth for 3Q16 was just revised upward again to 3.5% and the whisper estimates for 4Q16 suggest growth this past quarter was around 3.0%. All of this makes the marked slowdown in venture investing at the end of 2016 even more confounding, which was quite pronounced in some important sectors such as consumer service (40% decline in dollars invested) and e-commerce (62% decline). Alongside a handful of notable company struggles, the trouble with some high profile late stage companies seems to have rippled back to the early stage marketplace.

But by no means is it all doom and gloom on the investment front. For the entire year $69.1 billion was invested in over 8,100 deals and venture firms raised $42 billion. The median round size for early stage financings was $5.3 million last year versus $4.5 million in 2015, while later stage rounds stayed essentially flat at $10 million in size. It does appear, though, that much of the end of year pull-back in deal activity was seen in the sub-$5 million round size; in 2014 there were over 3,500 such deals while last year there were only 2,350 deals. Other highlights include:

  • For 2016, $33 billion was invested in 3,100 software companies, which continued to be the largest industry category and is nearly 4x in dollars invested as the next largest category, pharma and biotech ($7.8 billion and 515 deals, respectively)
  • Healthcare services and systems attracted $3.3 billion across 488 deals
  • The top ten financings in 4Q16 totaled $1.4 billion or in other words, 11% of invested capital went to 0.6% of the 1,744 companies which raised capital
  • Of the 8,136 deals in 2016, 29% were first round financings totaling $6.6 billion, which implies that nearly 90% of the total venture capital invested last year ($69 billion) was for follow-on rounds
  • Over $30 billion (or 44%) of the total investments in 2016 involved a strategic investor in the syndicate which underscored the important role corporates play in the venture capital industry (both as direct investors and LPs in venture funds). Notably in just 4Q16, corporate participation was just under 30%, perhaps signaling a “corporate pull-back”
  • Not surprisingly, corporate investors tend to invest later; 69% of their participation was in deals greater than $5 million in size
  • Just over 40% of last year’s investment activity was considered growth equity which is down from 46% in 2015
  • As point of reference, overall private equity investors closed on 3,538 transactions with a total value of $649 billion – VCs were just less than 10% of all private equity activity last year
  • 14 states had three or fewer venture financings in 4Q16, signaling that the VC model remains concentrated in a limited number of geographies

At its essence, investor confidence to make new commitments stems from perspectives about the exit environment and prospects for meaningful liquidity; the news here is less compelling – and getting worse. The weakness in IPO activity has been well chronicled (although, according to Renaissance Capital, if one had purchased a basket of all the 2016 tech IPOs, the return would have been 39.8% which is 5x better than the NASDAQ’s performance). In total, the 111 IPOs in 2016 raised $24.2 billion which was the lowest amount since 2003 and 33% below 2015 levels. Of the $46.8 billion in M&A activity for the 726 venture-backed companies sold in 2016, the median transaction value was $90 million which compares quite unfavorably to the median pre-money valuation of the growth equity rounds in 2016 of $141 million – that kind of stings. As a point of comparison, there were 1,040 M&A venture-backed exits in 2014 for a total value of $82 billion.

According to PitchBook, there were 3,538 private equity transactions in 2016 with a total value of $649 billion. This was a modest decline of 12% and 14% from 2015, respectively. Interestingly, the technology sector was nearly 25% of the total value and a high-water mark over the last 15 years.

There is another important emerging theme at play here, which is the increasing privatization of equity ownership. At the mid-point of 2016 there were 5,734 public companies in the US, which was approximately the same number as 1982 when the economy was roughly half the size. In 1997 there were 9,113 public companies. Clearly the stepped-up roles of private equity firms and sovereign wealth funds are contributing to this development. As shown below, the amount of capital held by those investors has increased nearly 5x over the last dozen years.


One of the implications of this increase in the number and size of the private pools of capital is the amount of the “capital overhang” sitting on the sidelines, waiting to be invested. Cambridge Associates has calculated that there is approximately $450 billion of capital which has been raised but has yet to be invested.


Globally, fund managers raised $602 billion of private capital across 1,228 funds according to Preqin Ltd, which are both modestly down from the 2015 levels of $637 billion and 1,486 funds, respectively. More specifically, venture capitalists for the year raised $41.6 billion over 253 funds; 50 funds closed on $7.3 billion in 4Q16 – the lowest quarterly total since 3Q15. Recent fundraising softness may, in part, be attributed to short-term VC benchmark performance. According to Cambridge Associates, the VC Index recently has trailed the Dow Jones US Small Cap Index – 3.3% vs 6.7%, 1.1% vs 10.7% and 3.4% vs 12.4% for 3Q16, year-to-date and prior one year, respectively. Other interesting elements that emerged in the 4Q16 fundraising data include

  • The top ten funds in 4Q16 totaled $4.7 billion or 64% of total capital yet were just 20% of the number of funds
  • Across all of 2016 there were seven funds raised which were larger than $1 billion in size
  • Per PitchBook the median fund size in 2016 was $75 million versus $40 million for 2015, reflecting the prevalence of $1.0+ billion funds
  • There were 22 “first time” funds launched in 2016 which raised $2.2 billion which was 9% and 5% of the totals, respectively, further highlighting the bifurcation of the venture industry between large and small focused firms


And in other parts of the world, the venture model continues to scale in important markets. For instance, in China there was $31 billion invested domestically in 2016, even though the number of deals declined by 42% according to KPMG. China was approximately 25% of global venture activity. Ominously, though, China’s debt to GDP which was 131% in 2008 and spiked to 235% in 2015, is projected by many analysts to increase to nearly 350% by 2020. In Israel, VC’s raised $1.4 billion in 23 new funds, which was 7% ahead of 2015 levels and is estimated to be $1.6 billion in 2017.


1 Comment

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One response to “Whoa Nelly – A Pullback on the Reins…

  1. Bruce MacDougall

    Michael , Your blogs are always excellent , well written and good content. Thank you, Bruce

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