Capital Rotation…

In a period of negligible interest rates, which was just reaffirmed for at least another month or two, investors are desperately looking for returns and many continue to find it in healthcare. According to the National Venture Capital Association, VC’s invested $17.5 billion in 2Q15 across all sectors; this was a quarterly high-water mark going all the way back to 4Q00 (almost 15 years ago). Of course, much of this was invested in late-stage break-out companies (Uber, Zenefits, etc), which arguably skews some of the data, but directionally it is quite clear that large institutional investors have piled into VC quite late in the cycle – never a good thing. Some troubling undercurrents are starting to emerge when one looks closer at the data.

Over $3.2 billion or nearly 20% of the dollars invested this past quarter was in healthcare, which is clearly understated as it does not capture the surge in healthcare technology investment (software businesses). According to StartUp Health, there was another $1.7 billion invested in “digital health” companies in 2Q15. Approximately $2.3 billion was invested in 126 biotech companies which is meaningfully more than the $1.7 billion invested in 1Q15. In fact, three of the top ten VC financings this past quarter were for biotech companies which raised an aggregate of $620 million. The medtech and healthcare services sectors, on the other hand, continue to play relatively small roles in the overall healthcare investment activity.

Why is this? Broadly speaking there are three factors to account for this rotation: (i) the re-invention of the “business of healthcare” is well underway which requires a whole set of innovative new software solutions as we go from a transaction-based system to one predicated on outcomes; (ii) the hyper-valued flurry of successful biotech IPO’s in 2014 through the first part of 2015 attracted significant public investor attention and capital given the promising advances in gene therapy and immune-oncology treatments; and (iii) all of this is juxtaposed to the still hostile regulatory, reimbursement and development timeline dynamics in the medtech sector. It is expected that another one billion people will join us in the next ten years contributing to a doubling of global healthcare spending so the long-term continues to be promising.

Because of the significant public market volatility this summer (which was unlike anything we have seen since 2008) due to China’s acknowledgment of slower growth and an expected period of interest rate normalization, it does appear that the euphoria in biotech in the first half of the year drew in many investors who now must feel somewhat scorned given…

  • The NASDAQ biotech index, which had been up 580% from March 2009 to July 2015, is now off nearly 20% from its summer high, having surrendered over $150 billion of market capitalization
  • Hilary Clinton tweeted how “outrageous” price gouging is for therapeutics (which knocked another 5% off the NASDAQ biotech index earlier this week)
  • 90% of biotech stocks in the Russell 3000 traded down in August 2015
  • In more than half of all biotech mergers this year, the stock of the acquirer dropped
  • According to Silicon Valley Bank, 40% of all biotech IPO’s in 2014 were for companies that had yet to complete Phase I studies (that is public VC, my friends)
  • There were 84 biotech IPO’s in 2014, but the pace has slowed materially with only 37 year-to-date (there were only 11 in 2011)

An important catalyst to this activity has been the role of healthcare crossover funds which were often significant large investors in the final private mezzanine rounds for many of these now public companies. Notably of the 26 venture-backed IPO’s in 2Q15, 20 of them were healthcare companies, many of them featuring large crossover funds on their cap tables. The question this raises is how these investors will behave when the IPO and M&A markets for venture-backed companies slow, which it inevitably will.

How is this playing out in Europe? This past quarter 52 healthcare companies raised nearly $510 million in venture capital, which is down over 13% from the year-ago second quarter. Through the first half of 2015, healthcare investment activity is down nearly 15% from 1H14 according to Dow Jones VentureSource data. The European market has always been smaller than the U.S. – in healthcare, about one-sixth the size – but appear to have pulled back sooner in Europe than in the U.S.

There were some extraordinary milestones achieved in the healthcare technology sector in the first half of 2015, perhaps none more notable than the tremendous FitBit IPO and the $500 million private financing for Zenefits. StartUp Health estimates that globally there are over 7,600 “digital health” companies which underscores both the global nature of these healthcare issues and the enormity of the opportunity (and unfortunately that barriers-to-entry have all but collapsed leading to too many companies). According to StartUp Health, 551 companies raised $6.9 billion in 2014 which would suggest that the 2015 pace is tracking behind that of 2014.

There were two other “funding” announcements this summer which nicely puts the venture capital data in perspective.

  • The House of Representatives voted 344-77 in favor of additional federal funding over the next five years for medical research at the National Institutes of Health by $8.75 billion which is approximately five quarters of venture funding. This bill also attempts to accelerate the approval of new therapeutics and devices by the FDA.
  • The other number which surprisingly did not get as much attention was the $6.5 billion paid by biotechs and device companies in 2014 to providers for consulting, research and promotional speeches. The Sunshine Act, which was part of the 2010 Affordable Care Act, required the disclosure of these payments. Of this total, $404 million was for “food, beverage, travel and lodging” or just under how much VC’s invested in medtech companies in 1Q15. They gotta eat (and drink and party)…

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Singapore – Racing Ahead…

Somewhere Over Alaska – What a fascinating time to have been in Singapore this past weekend. Concurrent with the Singapore Formula One Grand Prix, the country hosted the Singapore Summit 2015, their version of Davos in Asia (I was an invited guest of one of my firm’s investors and was honored to have been included). Both of these events were within a week of the national elections which returned Prime Minister Lee Hsien Loong and the ruling People’s Action Party to office with 69.9% of the vote, winning 83 of the 89 seats in Parliament.

My visit was also on the heels of two relevant events in the States: the decision to not raise interest rates and the second Presidential debate – both of which I often felt that I had to apologize for. Late last week, once the U.S. Federal Reserve announced its decision, the Singapore Strait Times Index traded off only 0.5% (some had expected greater volatility – the Singapore dollar actually strengthened). When it came to the Presidential debate, I was at a loss to explain to my hosts what that was all about. Was it a game show? Was it reality TV? Was it serious? That last question was the most difficult to answer.

Prime Minister Lee, who was extraordinarily gracious, spoke to the group over lunch, readily acknowledging his commitment to “leadership renewal” whereby he would announce a new Cabinet next week with a set of younger ministers. The ruling party had only secured 60% of the vote during the last General Election in 2011, in large measure due to issues around an influx of foreign laborers, access to affordable healthcare and the aging population (more later), rising housing prices, inequitable distribution of wealth – many of the same issues “addressed” in some measure in the U.S. Presidential debate last week. Interestingly, well more than half the population of Singapore had not yet to be born at the time of the country’s independence in 1965, and with voting being compulsory, the eight smaller opposition parties thought that they would have a much greater voice coming out of this election. That was not to be.

Many expressed great relief with the outcome of the election, pointing to the turmoil that was witnessed in Hong Kong as smaller opposition groups also demanded greater representation there. While faced with many of the same issues in Hong Kong, notwithstanding the fact that China does not claim ownership of Singapore, the Prime Minister appears to have set an agenda to address many of these difficult issues.

As McKinsey & Company pointed out in a regional analysis of Asia recently, this part of the world is dealing with a set of very disruptive forces – all evident and playing themselves out in Singapore today: (i) high degree of urbanization, (ii) technological advancements creating new sets of winners and losers, (iii) aging population and the impact on economic productivity, and (iv) global interconnectedness and trade flows.

A number of the healthcare initiatives are striking and promise to keep Singapore on the leading edge of care. The new National Cancer Center to be completed in 2020 will address issues around cancer which claimed 30% of the 19,000 deaths in 2014 in Singapore. This new center is expected to be one of the leading Asian centers for cancer research and education, often provided in partnership with U.S. academic and medical centers. The new National Heart Center was opened in 2014 and by 2020 a major new 550-bed community hospital will open in collaboration with Singapore General Hospital (which today handles 2,500 patients per week). The Strait Times had a headline this weekend stating that the National Sciences Authority will now allow the importation of non-approved therapeutics on a “named patient” basis to ensure people are getting state-of-the-art care.

But much of the attention this weekend was on the Grand Prix, which initially was thought to be in jeopardy given the level of haze that had settled over the city. At this time of year, many of the plantations in Indonesia “slash and burn” their fields which caused smoke to drift east creating a sooty fog over the city-state. Thankfully, the rains earlier in the week moved the Pollutant Standards Index from the unhealthy to moderate range of 70 – 92 PSI. Evidently, prior to the wet weather, the readings eclipsed 200 PSI which caused race organizers to stock up on something called “protective respiratory masks.”

Singaopre Grand Prix 2015

Starting after the Singapore Summit this week is the TechVentures conference which was to bring together the entrepreneurial community across the region. Analysts estimate that there are 55,000 start-up’s in Singapore which employ at least one person, and that in 2014, 5,400 companies raised some amount of capital. The Asian Venture Capital Journal reported that $324 million of venture capital was invested in Singapore in 2014 (which is 10x that invested in Hong Kong), although other sources report that as much as $850 million (which would include the numerous government grant and loan programs) was invested in the start-up community in Singapore.

All of this activity must be paying off to some extent. RBC Wealth Management earlier this year announced that the Asia-Pacific region now has more millionaires than that of North America, furthering inflaming Candidate Trump (“make America great again…”). Evidently there are now 4.672 million Asian millionaires which share 28% of the $56.4 trillion of global wealth. Given the regional volatility, the report goes on to state that Asians keep 23% of their wealth in cash.

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London Calling – Part II

Having spent the past few days in London meeting with investors and entrepreneurs, it was impossible not to be drawn into the painfully tragic Syrian refugee debate, poignantly jarring as we struggled to look at the photo of the drowned little boy. Remarkably, in the aftermath of that photo, many European countries welcomed refugees – literally with open arms, in some cities hundreds of cars were driven to the Hungarian border to pick up as many Syrian families as they could carry.

Toward the end of my trip much of the narrative shifted to what the U.S. should be doing, what is our obligation, our responsibility? Many Londoners felt that the U.S. in a very real sense set in motion a chain of events last decade which resulted in the largest European refugee crisis since World War II. It is hard to refute that position.

Most notably though, was how (relatively) peaceful it was unfolding. Obviously the extraordinary hardships families suffered to get to Europe are unimaginable, but once in Europe, there were no large-scale riots, no reported lootings. Many of the commentators remarked that it is often the “best and the brightest” who are displaced and that no-one choses to put their families through such fateful journeys.

I was reminded of two things these past few days. One, while growing up in Hong Kong in the 1970’s, was the Vietnamese “boat people” crisis who were fleeing countries across Southeast Asia – often times capsizing in the South China Sea with horrifically similar outcomes. The other more pedestrian observation was that relatively easy actions – reasonable diet, clean water, basic healthcare – have outsized benefits. We all know that, of course, but to see 100,000’s of people without that drives home how privileged developed economies are with quality healthcare infrastructure.

Which brings me back to why I was there. Four years ago I visited Tech City UK, London’s concerted effort to build a vibrant tech ecosystem – “Silicon Roundabout.” The progress is impressive as it now supports 40,000 start-up’s across the UK with 74% of those companies outside of London (as one Sunday headline in The Independent proclaimed “The hipsters have gone national”). Of the 40 “unicorns” in Europe, 17 are in Britain with 13 of those in London. Impressively, the Government’s Seed Enterprise Investment Scheme has invested 280 million pounds in this initiative, which just year-to-date has attracted an additional 1 billion pounds of private capital – quite interesting leverage on government dollars.

In addition to the sheer breadth of new company formation, nearly as impressive was the scale that the break-out companies have been able to achieve. The “Tech Track 100” follows the fastest growing technology companies in the UK – in aggregate these companies employ over 13,000 people and had revenues of 2.4 billion pounds in 2014; 52 of them are in London. Most of these companies were in the e-commerce, media, telecom, IT consulting, gaming, travel and advertising sectors. While some of the entrepreneurs I met with talked about more complete, innovative end-to-end healthcare solutions, somewhat disappointing was to see the lack of healthcare companies on the list – there were only two. Coming in at #9 was Immunocore (cancer therapeutics) which actually had raised the most private capital (205 million pounds) of all the companies listed, and Exco InTouch at #73 which was developing a mobile platform to track clinical trial patients.

So where were all the hot healthcare tech companies? The lead editorial in Sunday’s Times was lauding the virtues of genetic engineering (“Smile! Genetic Engineering is Good For You”) so clearly there was plenty of awareness. Not to wade into the debate around socialized medicine, but it does appear that a more robust healthcare innovation ecosystem still needs to develop, notwithstanding some of the very pressing needs as evidenced by articles “ripped from the headlines” this past weekend….

  • Cancer Research UK published a report quite critical of the National Health System (NHS) lamenting the lack of adequate cancer testing, imaging and surveillance. Apparently there are only 9 CT and 7 MRI scanners per million Brits – Spain has twice as many.
  • The NHS has now proven that death rates in UK hospitals are at least 15% higher on the weekends, after studying 15 million hospital admissions in 2013-2014. This translated into 11,000 avoidable deaths in that time period. Evidently the best day to have an acute episode is on a Wednesday. The root cause of this seems to be that “senior doctors opt-out” of weekend work.
  • Somewhat in the face of this is the stated “ambitious” plan for round-the-clock care when the NHS is cutting 22 billion pounds of annual spending. This announcement generated a lot of negative press.
  • In line with that though, the Cancer Drugs Fund announced that it would stop reimbursing for 25 specific cancer treatments which will likely affect the 24,600 people who accessed cancer treatments through that program.
  • BUPA, one of the largest UK healthcare providers, announced that it was selling its homecare business which provides services to 30,000 people, generating nearly 400 million pounds in revenues (but it loses money). Clearly there is an opportunity for business model innovation to get that service to be profitable.
  • And with great excitement, researchers at King’s College in London announced the development of a new blood test for ageing that will predict dementia based on one’s “biological age.” Just do not go to the hospital over the weekend to take that test.
  • Lastly, researchers at Imperial College London announced a new mobile phone app that applies an electrical current to one’s head to reduce the nausea associated with sea sickness. Maybe this will be the third healthcare tech company to break the Tech Tracker 100. Better yet, maybe this app can alleviate the sickness experienced with extreme stock market volatility.

And that was just the lead stories in the last few days. Speaking of stock market volatility (and the crack down on Chinese corruption, the devalued Russian ruble, the precipitous decline in oil prices, regime changes in Africa, etc), high-end London real estate is now suffering; we learned this weekend that the number of transactions was down 23% last quarter over the same quarter in 2014.


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Rock The House…From Silicon Valley to China

It’s that time of the quarter when venture capital fundraising data are released by the National Venture Capital Association (NVCA), possibly leaving all the sophisticated investors across the industry wringing their collective hands about frothiness. The latest data shows that VC’s in 2Q15 raised over $10.4 billion (slightly revised upward from the announced amount last week) across 74 funds – this is a 39% step-up from the amount raised in 1Q15 and a 27% increase from 2Q14. This is the largest amount raised since 4Q07 – do you remember what happened in 2008? Wow.

As usual the headlines tend to mask some important developments one sees when wading through the data. The VC industry continues to consolidate around a limited number of managers who raise large funds with large Roman numerals attached to them. There continues to be evidence that Limited Partners will occasionally support smaller, very focused funds but the land of mid-sized funds continues to shrink; only 9 of the 74 funds were between $100 – $300 million in size (disclosure: my firm – Flare Capital Partners – announced this quarter a $200 million fund which we believe is ideally suited to focus intensely on early stage opportunities, yet be “life cycle” investors and support our entrepreneurs across every round).

On a trailing quarter annualized basis the VC industry is tracking to raise $40 billion this year, which would be the most raised in nearly 15 years. Related, announced this morning were the VC investment data which show that VC’s invested $17.5 billion in 2Q15, implying an annual investment pace of nearly $70 billion. This $30 billion projected “funding gap” for 2015 is largely filled by non-VC investors (hedge funds, corporates, sovereign wealth funds, mutual funds) who arguably are looking for greater returns than what is available elsewhere in other asset classes. The question this begs is how will these investors behave when the tide inevitably turns. The other concern imbedded in all of this is one of absorption – that is, can the VC industry “productively” deploy $40 billion across 4,000 +/- companies this year? As of the end of 2014, the NVCA estimated that the U.S. VC industry to be ~$160 billion of assets under management which is meaningfully smaller than the $200 billion average size over the last 15 years. Given many firms could not raise funds during the recession, and those firms that could raise funds tended to raise smaller funds, the VC industry naturally shrunk; the concern now is that it might expand too rapidly.

2Q15 Funding Gap

Now for some interesting nuggets in the detailed fundraising data…

  • Of the 74 funds raised, 31 were considered “new funds” but they only raised $1.3 billion or 13% of the total yet they were 42% of the firms
  • Average size of “new fund” raised is $43 million which is overshadowed by the average size of the “follow-on” funds raised of $212 million – clearly success begets success
  • The largest “new fund” raised was $250 million by Geodesic Capital (congrats) while New Enterprise Associates raised the largest overall fund of $2.8 billion (not counting a separate $350 million side-car fund) – so Limited Partners will dabble with new managers but just not too much
  • The Top Ten funds raised $7.2 billion or 70% of the capital in 2Q15
  • The Bottom Ten raised $14.3 million or 0.14% of the capital – not a typo
  • 7 of the Top Ten funds are based in California and represent $6.3 billion
  • In fact, overall, California funds account for $7.7 billion or 74% of capital raised
  • And while 18 states were represented on the list, outside of California, Massachusetts and New York, fund managers in those other 15 states raised just $1.1 billion or 11% of the capital

California, specifically Silicon Valley, always leads where venture capital dollars are invested – typically ~60% of all dollars are invested each year in California-based companies. What is notable here is the extreme level of concentration of the underlying fund managers. When so much of the capital is managed in a single geography are we at risk of creating an “echo chamber” which drives herd/irrational behavior? Does this naturally lead to the overfunding of new categories as each firm wants its own portfolio company in a given category?

And as a point of comparison, given that I grew up in Hong Kong and remain fascinated about the emerging capital markets in China, that market always provide a provocative juxtaposition. The last few years have ushered in extraordinary change in China: the capital flows are staggering and now so is the volatility and issues of absorption. Some interesting – almost unbelievable data – coming out of China this past quarter…

  • 4,000 new hedge funds were launched in 2Q15, mostly focused on equity investments, funded principally by the emerging class of 90 million new retail/individual investors in China
  • There are now 12,285 hedge funds in China employing 199,000 people according to the China securities regulatory authorities
  • Year-to-date 2015, $452 billion of public and private equity – that is billion with a “b” – was raised in China according to J Capital Research
  • There is estimated to be $320 billion of short-term margin loans outstanding; these typically have a 6-month duration, with much of them held by these new retail investors – with these loans coming due, the recent volatility in the Chinese stock exchanges starts to make more sense. Citigroup estimated that some $4 trillion of equity valued was lost – this is twice the size of India’s economy
  • That is nothing though – $8.5 trillion of debt has been issued in China year-to-date and when combined with the $1.1 trillion of corporate bonds issued, this brings the total China debt load to over $28 trillion

Now that will be fun to watch play out…

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Winner Takes All?

Last week I spent some time with Peter Diamandis, founder of the XPRIZE Foundation and Singularity University (among dozens of other initiatives), who quite simply is trying to solve some of the world’s greatest problems. What was most striking about the XPRIZE vision to democratize innovation was how effectively the model corrals entrepreneurs with a very clear “call to action” – where the winner takes all.

The reward incentive competition model crowdfunds solutions – full stop – and does it very efficiently with a clear end point. The Qualcomm Tricorder XPRIZE competition is offering $10 million to the team which can build a handheld diagnostic device (the “Star Trek tricorder”); over 330 groups started to work furiously to build it – 10 are still at it. There are nearly a dozen current XPRIZE’s underway with another dozen in development.

The juxtaposition to what we are seeing today in the private capital markets in healthcare technology is striking; winner certainly does not take all but rather will have to share the spoils with many other emerging competitors. There has been an explosion in the number of start-up’s attempting to solve the numerous problems across the entire healthcare ecosystem. Providers and payors have a myriad of important and distinct business issues they are looking to the start-up community to help solve. The “call to action” is less clear, certainly not as precisely articulated as the XPRIZE model, which risks leading to too many companies solving more narrow, maybe the wrong, issues. According to Rock Health, over $4.1 billion was invested in nearly 260 start-up companies in 2014, which effectively matched the total amount invested for three years from 2011 to 2013.

The forces which conspired to make this so are reasonably well understood. Reform as evidenced by the Affordable Care Act ushered in a wave of innovative approaches such as healthcare insurance exchanges which brought millions into the healthcare system but also forced consumers to start weighing cost and quality in their healthcare purchasing decisions. The proliferation of technologies around mobility, analytics, and inexpensive IT infrastructure meaningfully reduces the friction to adopt new solutions. The aging population and better understanding of clinical pathways and disease states are driving greater urgency. And my favorite, effectively free money, has made the financing of these new start-up’s relatively straight forward.

Notwithstanding that we are talking about a $2.9 trillion slice of the economy, the question now is one of absorption; that is, can the market make productive all of these new companies? Entrepreneurs salivate about disrupting the incumbents, driving down/out waste and inefficiencies. Many of these new companies are run by people who have successfully built similar solutions in other industry verticals (financial services, commerce, advertising come to mind) over the past 20 years. But like many of those other verticals, there is a natural cycle to how these markets develop – where are we on the curve below?

Winner Take All

Maybe contributing to this phenomenon is the short attention span of VC’s. My friend Professor Tom Eisenmann at Harvard Business School partnered with DocSend (a platform for entrepreneurs to share diligence materials and legal documents with prospective investors) to analyze over 200 investor presentations. The average presentation was reviewed for 3:44 minutes – not hours. Obviously there are a number of meetings involved in the diligence process, but 41% of those companies closed their seed round of financing in less than 10 weeks – Series A rounds were even faster. The pace is frenetic right now.

This all can work with robust and predictable liquidity alternatives. A number of analysts are calling for a significant spike in the number of healthcare technology IPO’s given the level of private capital now invested in the sector, and in fact we recently saw a handful of exciting IPO’s either price or be filed (Evolent traded above $1 billion and FitBit will break the $3 billion valuation barrier on $750 million of revenues). But today more companies are choosing to stay private much longer (thanks, in part, to the 2012 JOBS Act which increased from 500 to 2,000 the number of shareholders private companies are allowed) which may create a crush at the exits when/if the tide turns.

  • Sand Hill Economics estimates that at the end of 2014 the total value of all venture-backed companies was $750 billion or ~2.5% of the total value of US public companies (ominously, the last time it hit 2.5% was in 2000)
  • Across all sectors, IPO activity year-to-date is only $15 billion which is the lowest amount since 2010
  • For venture-backed companies there has been $20 billion of “private IPO” activity year-to-date as opposed to only $600 million of traditional IPO proceeds for VC portfolio companies
  • In 2014 Second Market traded $1.4 billion of secondary shares (the alternative stock exchanges are rapidly maturing) and we are seeing the advent of private derivative contracts trading in unlisted tech companies
  • In May 2015 alone, there was nearly $243 billion of M&A activity; interestingly for the 12 months through March 2015, 13% of all healthcare companies had received takeover offers
  • Year-to-date 2015 there has been ~$100 billion of monthly corporate bond issuances

So capital is plentiful – but traditional IPO activity is meaningfully down. The implication of this is debatable. Are founders and VC’s rolling the dice, trying to thread the needle by “going long” given the seduction of the lofty valuations in the private capital markets today (obviously ignoring the complicated terms of these later stage rounds which may make high valuations illusory). Or has the world fundamentally changed? Didn’t we all say that the last time?


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Breaking News: Flare – Up and to the Right….

Today we announce both a new brand and a new fund. While we liked our prior name – Foundation Medical Partners – it was time to refresh our presence in the market. A few other venture firms use the word “Foundation” in their names and there was chronic confusion with Foundation Medicine, a very exciting diagnostics company. Additionally, we don’t do “Medical” but rather invest in healthcare technology companies, both software and service business models. But we do very much like “Partners” thus the new brand – drum roll, please – Flare Capital Partners.

The word “flare” evokes important associations with energy, momentum – up and to the right. Flares light the way, are bursts of intense flame, they light up what is dark. We love the imagery and think it is powerful.

Separately but related, we are also announcing our new fund – Flare Capital Partners I. This $200 million fund is considered to be the largest dedicated healthcare technology venture fund raised. The transformation of the healthcare industry landscape has given rise to tremendous new market opportunities for the fund to pursue. In fact, we have already made four investments out of this fund. And we think the best way to service entrepreneurs in this large and important sector is to do so on a dedicated basis.

One of the hallmarks of Flare Capital Partners I is the composition of the Limited Partner base, which we think is highly differentiated. Many of our investors are directly engaged in the transformation of healthcare, running some of the most important companies from across the entire healthcare ecosystem. Additionally, we are privileged to partner with leading pension funds, sovereign wealth funds and family offices – all excited about the ability to build important and valuable new companies in the business of healthcare. We are honored to have them all as partners and expect that many will be tremendous assets for our entrepreneurs.

This next decade will be very exciting. Let the games begin – and let Flare light the way…


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Head Scratching Data…

Grinding through all of the 1Q15 investment data does not necessarily provide additional clarity as to where the private capital markets are heading. The number of new venture capital funds declined markedly from the torrid pace set in 2014 but new investment activity continue to crush it. Clearly non-VC’s are still piling into the early stage marketplace, looking for returns.

Specifically, 62 venture funds raised $7.3 billion in 1Q15 (recently updated from the formal announcement of a few weeks ago), which was a decline of 23% in the number of funds but was a 26% increase in the amount of dollars raised when compared to 4Q14 – 80 funds and $5.8 billion, respectively. In 1Q14, 58 funds raised $8.9 billion so it does appear that the venture industry has settled into a fundraising range of $20 – $30 billion annually, which is what it was for much of the last decade between the recessions. It also appears that the “barbell” phenomenon of the venture industry continues along and is underscored further by some specific highlights in the 1Q15 data. As a point of reference the overall US venture industry is estimated to be about $200 billion of capital under management.

  • 42 of the 62 funds raised were less than $100 million in size
  • Of those 62 funds, only 18 were considered “first time” funds, the largest of which was F/K/A Ventures which was – truth be told – the IT investment team from Atlas Venture when the firm split up
  • The five largest funds raised $3.8 billion – 8% of the funds raised 51% of the dollars
  • 32 funds were less than $25 million in size…4 of them were less than $1.0 million (not a typo)
  • The average size was $118 million which is a meaningless (or misleading) number when the median is $20 million
  • The largest fund raised was $1.6 billion – congrats Bessemer – which was 2,909x the size of the smallest

Interestingly, the pattern of hedge fund commitments has also changed significantly in the past few years with it bifurcating to support either much smaller or very large managers. Both ends of the spectrum captured most of the dollars, leaving mid-sized managers to struggle to raise capital. In 2014, “small” hedge funds – those with less than $5 billion under management (even though one of those funds is over two-thirds of what the entire VC industry raised last quarter) – raised ~50% of the total $76.4 billion of hedge fund commitments. In 2012, large hedge funds raised $93 billion while these same small hedge funds suffered aggregate withdrawals of $63 billion. Whiplash.

Venture investment in 1Q15 totaled $13.4 billion in 1,020 companies. This is nearly a 10% decline in dollars invested and an 8% decline in companies when compared to 4Q14, but is an increase of 26% on a dollars basis from 1Q14 on about the same number of companies. Quite clearly the trend for venture-backed companies to raise larger and later rounds of private capital continues. And it is this phenomenon which further exacerbates the “funding gap” now so present in the venture marketplace. Arguably, non-VC investors have plunged into the venture asset class looking for greater returns.

Funding Gap 1Q15

It is not surprising then that seven of the top ten largest venture financings in 1Q15 were in consumer facing companies, which has drawn so much investor attention. In fact the top ten companies raised $3.8 billion in the first 90 days of 2015 or stated in another more shocking way – 1% of all companies which raised venture capital in 1Q15 soaked up 29% of the dollars invested. Some other interesting nuggets in the data:

  • Seed activity continues to decline significantly and was only $125 million (26 companies) – admittedly, we may a “quality of data” issue here as this just seems wrong
  • Expansion and Later Stage rounds captured 72% of dollars invested in 1Q15 as compared to 61% in the prior quarter, underscoring the rotation to more mature companies
  • The Biotech sector rocked in 1Q15, clearly driven by the biotech IPO window being thrown wide open in 2014 – those 124 companies raised $1.7 billion; all in, healthcare companies raised $2.3 billion
  • The largest category continues to be Software where 434 companies raised $5.6 billion for an average round size of $13.3 million
  • Sadly, the Networking and Equipment category only raised $99 million across 9 lonely companies

Liquidity ultimately drives flows of capital into the venture industry – we all know that. The industry’s ability to recycle capital is critical but may also be a poor trailing indicator of future success. This past year witnessed exceptionally strong M&A and IPO activity with $48 billion of venture-backed M&A transactions (there were 479 in all, but only 139 disclosed the transaction values, so the total is undoubtedly much higher) and 116 IPO’s which raised $15 billion of capital.

The story in 1Q15 is more disconcerting as there have only been $2 billion of announced venture-backed M&A transactions (86 in total, 16 of which had announced values) and a mere sliver of IPO activity – $1.4 billion raised across 17 companies (13 of which were biotech companies). Nearly 25% of total 1Q15 M&A volume was due to Under Armour’s acquisition of Myfitnesspal, evidently leaving a large number of modest trade sales behind. Clearly 2015 is off to a more measured pace which may limit fundraising activity in 2016, although there are nearly 55 companies currently filed publicly for IPO’s.

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