Rinse and repeat. In many important ways this past year felt very much like 2018. Many pundits had expected that the great bull market would finally come to an end, interest rates would rise, inflation would kick in, and unemployment rates would start to increase. None of that happened.
While there was a notable shift in investor sentiment on profitability over growth at all costs, particularly in light of the failed WeWork IPO, the $136.5 billion of venture capital investments in 2019 nearly hit the all-time high of $140.2 billion registered in 2018. Ten years ago, coming out of the Great Recession, venture capitalists invested just over $31 billion, less than a quarter of the current activity. Quite clearly this robust pace was driven by an extraordinary year for exit activity. For all of 2019, there were 882 liquidity events which totaled $256.4 billion in exit value, a high-water mark nearly doubling any prior year and perhaps not likely to be seen again.
But be forewarned: 2019 was the first year in nearly 20 years that 40% of all public companies lost money (negative net income) and yet the Dow raced to 29,000, now trading at 25x P/E ratio for the S&P 500 index.
As with any headline, there are nuances beneath the surface which make the story somewhat more complicated. As shown below, even the quarterly investment pace slowed significantly in the number of financings and likely suggests growing concerns among VCs to make new commitments heading into an election year with an impeached President and the Dow now marching to 30,000. Even the exit activity was heavily weighted to the first half of 2019 and skewed by the $75 billion valuation of the 2Q19 Uber IPO. In fact, this past quarter saw only 174 exits valued at $18.8 billion.
Notwithstanding that the 4Q19 pace is more than $13 billion less than what was registered in 4Q18, for the entire year the amount invested and number of deals across all stages were relatively consistent between 2018 and 2019. This past year there were 4,556 angel and seed deals which raised a total of $9.1 billion as compared to 4,541 and $9.2 billion in 2018, respectively. For early stage investments the amount invested and number of deals were $42.3 billion and 3,624 in 2019 and $43.3 billion and 3,722 in 2018, respectively. The same holds true for late stage activity: $85.1 billion and 2,597 in 2019 and $87.7 billion and 2,279 in 2018, respectively.
More than 62% of all capital invested in 2019 was in late stage deals, suggesting that investors may be focusing on less risky, more mature opportunities. In point of fact, 181 deals in 2019 were larger than $100 million; 53 of those 181 deals were for early stage companies, raising $9.7 billion (or 23% of early stage deals were larger than $100 million).
According to Crunchbase, globally there were 455 financings in 2019 that were greater than $100 million in size, raising in total $108 billion. Given the increased scrutiny on IPOs (and the possible emergence of direct listings which largely side-step Wall Street), it is noteworthy that of all of the “mega rounds” greater than $100 million between 2008 – 2015, 19% of those companies went public – a rate far greater than companies that did not raise such a round.
All of this robust investment activity in the late stage marketplace has clearly put upward pressure on valuations as shown below. A mere five years ago median late stage valuations were just over $50 million and now are close to $90 million (average late stage valuation in 2019 was $488 million, clearly skewed by the 155 unicorn financings) as shown below. Median late stage round size was up slightly over the last five years from $9.0 million to $10.4 million in 2019, suggesting that investors now are owning a far smaller percentage of these companies. Another implication is that early stage investors are showing dramatic unrealized mark-ups in their portfolios.
The real story in 2019 was about exit activity. Of the 882 exit events, 627 were acquisitions and 80 were venture-backed IPOs. Interestingly, the investments to exit ratio was 12.2x in 2019, a level not seen before (2018 was 10.4x) indicating a growing backlog of private companies. While the $256.4 billion of exit values last year somewhat masks a relatively weak 4Q19 for exits, undoubtedly significant liquidity to LPs will be recycled as new commitments to new funds. Fundraising last year hit $46.3 billion across 259 funds which was the second strongest year behind the $58 billion raised in 2018. The median fund size was $79 million while the average fund size was $182 million, highlighting that the venture industry continues to see a “barbell” phenomenon with a handful of mega funds co-existing with many small micro funds; 93 funds were less than $50 million in size.
According to Preqin, there is $276 billion of “dry powder” held by US venture funds, which is ~3x the level in 2012. Preqin also estimates that there is $365 billion held by Asian venture capital firms, of which $100 billion is uninvested “dry powder.”
Elsewhere, the level of U.S.-based venture capital investment in China is estimated to have dropped to less than $4 billion last year from an extraordinary level of $17.4 billion in 2018, according to an analysis by the Rhodium Group. Obviously, this reflects the grinding trade war with the U.S. but also may be impacted by China’s 6.1% GDP growth rate in 2019, meaningfully below 7.0% – 10.0% over the past decade. The level of venture capital invested in the U.K. hit a record of $13.2 billion in 2019, an annual increase of 44%. Germany and France venture capital activity increased 41% and 37%, respectively. Clearly in an economic environment with near-zero interest rates and uncertain GDP and trade growth rates, investors appear to be seeking return investing in innovation in relatively stable jurisdictions.
Extraordinary levels of raised capital was not just for venture capitalists. Preqin also flagged that the private equity industry has $772 billion of “dry powder” and raised $595 billion globally last year. Perhaps signaling investor desperation for yield, more than 25% of all IPOs last year were by special purpose acquisition companies (SPACs) which do not have any operations and are “blank check” companies whereby the issuer then has two years to acquire an asset. Over $13.6 billion was raised in 59 SPAC IPOs last year. And all of this against a backdrop of lower rates and a Federal Reserve that injected a few hundred billion dollars into the financial system this past fall. Hmmm.
So, this will close with a word of caution and that involves global debt levels, which hit a record of $253 trillion (with a “T”) in 3Q19 according to the Institute of International Finance. The debt to global GDP ratio of 332% is also a record and cause for significant alarm. While much of this debt are obligations of governments and non-financial corporations, the risk for systemic instability is real and very present should interest rtes spike or global economic growth continues to slow.