Now that most of the investment data are in for 1Q17, analysts are using words like “disciplined” and “normalized” to describe the activity of the first 90 days of 2017 – obviously not how we would characterize the current political climate. As always, the headlines belie what might be seen as more turbulent private capital markets under the surface, as quite clearly there is a continued and pronounced rotation away from the earliest stages of investment. Modest but encouraging exit activity has continued to generate strong limited partner interest as 58 new funds raised $7.9 billion, according to NVCA and PitchBook data.
Nearly $16.5 billion was invested in 1,797 companies in 1Q17, which was the fewest number of companies in the last 22 quarters. Much of this decline was in the Angel/Seed stage which over the past handful of years has accounted for roughly 55% of overall deal activity but only 45% this past quarter, signaling that investors may be somewhat more risk averse as they focus on later stage companies. The number of Seed companies dropped by 46% over the past eight quarters. While Seed rounds have consistently stayed at $1 million in size, average Later Stage VC round size was $10 million as compared to $5.5 million for Early Stage VC rounds.
The “bread and butter” of the venture market are the Early Stage financings and there the data are also mixed. Deal volume has declined quarter-over-quarter for each of the last eight quarters and in 1Q17, Early Stage accounted for only 30% of all deals, and at $5.7 billion of transaction volume, was only 35% of all dollars invested. The landscape is quite different in the Later Stage VC rounds where the number of deals has increased sharply over the past three quarters, accounting for nearly 25% of all financings yet 57% of all dollars invested. This concentration is underscored when one considers that the top ten financings were 17% of all dollars invested yet were only 0.6% of the companies. Two of the top five venture deals were in healthcare.
Arguably even more striking as a barometer of venture investor risk tolerance is the dramatic pull-back away from companies which are raising capital for the “first time.” Only 497 of the 1,797 companies in 1Q17 raised venture capital for the “first time” which is the lowest number in 27 quarters and half of what it was just three years ago; together those companies only accounted for 10% of dollars invested in the quarter. First time entrepreneurs are not excited about this “disciplined and normalized” market.
Undeniably, corporate venture funds have played an important, perhaps even stabilizing, role in the venture capital industry. Corporates have consistently invested in between 270 to 350 deals over the last five years, with much of their participation being in Later Stage investments. Overall, Corporate VCs participated in 38% of all 1Q17 financings.
Exit activity is what makes the venture model sing, and the news in 1Q17 was encouraging. Overall exit values for venture-backed companies was $14.9 billion across 169 companies. While the number of exits has not been this low for the last 24 quarters (maybe reflecting corporate chieftain uncertainty in light of the election results), the value of deal activity is consistent with that of the prior eight quarters. Unfortunately, there were only 7 venture-backed IPOs but anecdotally investment bankers, who are normally an anxious lot, appear to be encouraged with both the number and quality of companies in front of the SEC waving their draft S-1s. Somewhat disconcerting, though, was that Snap likely overwhelmed the IPO market in 1Q17, raising $3.4 billion of the $4 billion of total IPO proceeds. The sector with the largest number of exits was Software (96) which was 57% of all exits, and compares favorably to the fact that Software was only 37% of all deals financed in 1Q17.
This introduces another interesting metric which investors are increasingly grappling with. Since 2013 the ratio of new investments to exits has been between 10 – 11x, which is nearly 3 to 4 points higher than what was experienced ten years ago. Of course, the math is crude given the timing differences, but undeniably, companies are staying private longer, and for some, that has been aided by aggressive hedge funds and mutual funds. For others, this may not be of their own choice. There are many market whisperers now speculating which of the 153 “unicorns” (per Venture Source) are facing a dystopian future should they not get liquid in the next 12 months.
For the past four years, there have been consistently between 60 and 70 new funds raised each quarter. Between 2014 – 2016, the venture industry has raised between $35 – $40 billion annually and appears to be on pace to raise in the low $30’s billion in 2017. This past quarter was the first one in recent memory when there had not been a $1 billion fund raised (Mithril was the largest at $850 million). Notwithstanding that, the ten largest funds raised accounted for $4.3 billion or nearly 55%, yet represented only 17% of all funds raised.
Other fun “quick hit” venture facts from this past quarter:
- According to Preqin, $31 billion was invested in 2,420 venture deals globally
- Since 2013, over $1.5 trillion has been distributed back to investors from private equity and venture capital firms
- This liquidity may account for why there was $90 billion raised by 175 PE and VC firms
- It is estimated that there are over 1,900 PE and VC funds “in market” now, targeting to raise $635 billion, inclusive of the unprecedented $100 billion Softbank Vision Fund
- And staying with Preqin, at the end of 1Q17 it is estimated that there is $683 billion of PE and $159 billion of VC “dry powder” capital still to be invested globally
There were two other market developments that many found surprising. Given all of the political volatility, the Dow Jones Industrial Average had the quietest trading quarter since 1965, with average daily price movements of only 0.3185%; for the S&P 500 it was only 0.3172%. The lack of volatility has put many market analysts on edge – ironically.
And business lending (bank loans and leases) increased a very modest 3.8% year-over-year in 1Q17. Over all of 2016, business lending rose 6.4%. Admittedly corporate bond issuance increased 18% as large issuers locked in historically low interest rates (and maybe even paid off some bank debt). Why this is somewhat disturbing is the downstream impact on growth; Goldman Sachs estimated that this deceleration effectively created a $100 billion loan shortfall.
Maybe Softbank can fill that void.