Do you remember that the President was impeached earlier this year? Easy to forget amidst the pandemic, recession, stock market crash, then raging stock market bull, record low then record high unemployment, and a nasty presidential election. Head spinning. Through it all, the venture capital industry has shown extraordinary resilience with another terrific quarter – $37.8 billion invested in 2,288 companies.
Confoundingly, 3Q20 saw a strong, yet incomplete, financial resurgence alongside a staggering resurgence in COVID-19 cases; three days ago we saw an all-time daily high in cases. As cases surged over the last few months, the S&P 500 index increased 7.9% in 3Q20, while the NASDAQ was up 9.2%. U.S. large cap stock funds powered ahead 11.8%. On the heels of unprecedented job losses this spring, the unemployment rate is steadily improving – although too slowly for many and still miles from where we were pre-COVID.
According to National Venture Capital Association (NVCA) data, $112.3 billion has been invested in 7,891 companies year-to-date. One might have expected a pause this summer, but that did not happen. While the deal count is decreasing, the amount of capital invested continues to be quite robust. The size of the average investment in 2020 so far is $16.5 million, well ahead of the $11.7 million this time last year. Quite clearly, there is a greater proportion of Later stage deals and a greater number of large financings this year, perhaps signaling further concentration around fewer companies as well as a greater degree of risk aversion among VCs who may be shifting attention to more mature businesses. The number of financings greater than $50 million in size so far this year was 6% of the total count yet accounted for 63% of all dollars invested.
This quarter saw the continued collapse in seed investments, both in numbers and dollars. There were 469 seed deals, nearly half as many just two years ago, and a more modest $2.0 billion invested (average size of $4.3 million). Interestingly, angel investment activity remained relatively consistent over the past five years with between 500 – 600 deals per quarter. Early stage also continued the steady decline in activity first seen in early 2019. This past quarter $9.2 billion was invested in 657 Early stage companies for an average round size of $14.0 million. Later stage also saw a marked decline in the number of deals, decreasing to 662 in 3Q20. The quarterly pace was between 750 – 850 over the last six quarters. The amount invested in Later stage companies was $26.6 billion for an average deal size of $40.1 million.
The story in 3Q20 centers mostly around the number of “mega rounds” of greater than $100 million in size. The chart below shows the median round size by stage, highlighting the impact of a few large financings when only focusing on average round size (above). There were 79 “mega round” financings this past quarter, totaling $17.7 billion; strangely ten of these were considered Early stage. Companies raising such large rounds tend to be meaningfully de-risked and are now scaling, maybe (again) suggesting less risk tolerance among venture investors. To underscore this development, there were only 542 first-time financings this quarter, which is the lowest level in a over a decade.
There were a handful of other interesting insights in the 3Q20 data. Year-to-date $63.7 billion has been invested in West Coast companies, which is more than the rest of the country combined. While the dollars are more concentrated in fewer geographies, the number of companies appear to be more distributed, perhaps in response to the pandemic. So far this year, only 38% of companies raising venture capital are on the West Coast. The top three states (California, New York, Massachusetts) represented 75% of the capital invested but only 53% of the number of companies.
One other observation in the funding data worth highlighting: the level of participation by corporate venture capital groups continued its sharp decline and was only 17.6% in 3Q20, a level not seen in nearly a decade. This participation rate tends to be between 20 – 25% of all financings. Such a pull-back may be a direct result of the financial pain inflicted by the pandemic.
Arguably, the strong investment activity this past quarter was bolstered by the exceptional level of exits, driven by a very robust IPO market. The $103.9 billion of exits in 3Q20 was the second-best quarter, nearly 4x the prior quarter and only below the high-water mark of the “Uber IPO quarter” of 2Q19 ($144.8 billion). More typical quarterly exit activity for venture-backed companies tends to be between $20 – $30 billion. Globally, M&A activity surged 80% in 3Q20 while in the U.S. merger activity increased 23.5% quarter-over-quarter.
Exit activity is best considered alongside private round valuations. Median valuations have steadily increased by stage over the course of the last decade and saw no appreciable COVID impact. In fact, given the impact of “mega rounds,” the average Later stage round valuation was $672 million (versus median valuation of $90 million). Median Early stage round valuation of $30 million year-to-date is modestly higher than $28.1 million in 2019, underscoring the significant step-up in valuations available to companies once important milestones are achieved. Given average round sizes, these data also imply that investors tend to end up owning roughly one-third of Early stage companies.
In a period of extraordinarily low interest rates, returns generated by venture capital funds both on a relative and absolute basis continue to be very compelling. Since 2011, according to NVCA data, the venture capital industry has generated net cash distributions each year through 2019 and is expected to do so again in 2020 given the level of exit activity. This dynamic likely accounts for the strong fundraising environment many established firms now enjoy.
Eighty funds raised $13.9 billion in 3Q20, averaging $173 million per fund; this level already exceeds all of 2019. For the year so far, venture capitalists have raised $56.6 billion across 228 funds. Notably, 35 of these funds were larger than $500 million, furthering the concentration of capital with a relatively small number of tenured branded firms. Year-to-date, there have been 30 “first time” funds which have raised $19 billion; in 3Q20 only 16 “first time” funds raised $390 million ($24 million average size).
Separate but related, this past quarter saw the explosion of Special Purpose Acquisition Companies (SPAC), blank check public shell companies that have a limited window to close an acquisition, often of mature venture-backed companies. There are now 185 such vehicles with $58 billion of capital trolling around the market looking for assets to acquire. While in recent weeks there is evidence of waning public investor appetite as a number of pending SPACs have been downsized, this is undeniably an important development in the venture industry, offering yet another potential path to liquidity.
Of course, there are a number of other significant issues weighing heavily on 4Q20 activity. According to the U.S. Treasury, the national debt now stands at a daunting $27.1 trillion which tends to put everything else in sharp focus. Unfortunately debt isn’t what it used to be. According to Blackstone, debt incurred today has much less of an impact on GDP growth than it did decades ago.
And then there is the pandemic, elections, elevated unemployment levels, tensions with China…oh wait, all of those have existed for some time now. Let the good times roll.