Will VC Valuations Come Down To Earth? by PitchBook
Introduction
Is the U.S. VC market in bubble territory? There’s no shortage of commentary on the subject, but the conversation was more theoretical before the stock market dipped in late August. For startups and their investors, high valuations feel more uncertain today than they did 12, six, even three months ago. Most of the data in this report is through the first half of 2015, before the stock market lost its footing. As such, they could represent a high point in round sizes and valuations across any—or all—stages. Even if stock prices recover over the next few months, it wouldn’t be surprising to see valuations come down to earth as the year progresses.
Through June, however, valuations kept climbing. Seed valuations hit a median $6.1 million, a record. Markups at the seed stage have pushed up Series A and B valuations to $15.1 million and $41.4 million, respectively, up from already high medians of $12.6 million and $35.3 million in 2014. Later stage trajectories were even steeper, and arguably more vulnerable to the latest downturn in public markets. At a median $184 million, valuations at Series D and later stages are the most likely to get hit in the coming quarters. So-called “unicorns”, startups valued at $1 billion or higher, are set to get the most scrutiny. As we detail on page 13, the number of U.S.-based unicorns has almost doubled this year. Another 31 startups joined the club through August, on top of 32 new unicorns minted last year. It’s taken less time for this year’s unicorns to reach billion-dollar status; the time between their prior rounds and unicorn rounds fell to a median 1.1 years, and median valuation step-ups from those prior rounds fell to 2.1x compared to 10x in 2012.
One reason for the rise in unicorns (and high valuations in general) has been a steady migration of mutual fund investors into the asset class. We dove into that trend on page 15 and found some interesting results. Late stage rounds with mutual fund participation skyrocketed in 2014 (no surprise there) and stayed high through 1H 2015. Starting this year, however, mutual funds have crowded into earlier stages, as well, causing the median early stage valuation (Series B and prior) to jump to $56 million. The 2014 median was a much more modest $13.6 million, about half of what it was in 2007.
Overview
If U.S. VC activity is in for a correction, it’s going out on a high note. $21.8 billion worth of investments were inked in 2Q, yet another post-crisis record. The past five quarters have either nearly hit or eclipsed the $15 billion mark, compared to zero prior to 2Q 2014. At the same time, the number of rounds has steadily waned since the 2,200 seen in 1Q 2014. This past quarter’s total fell to 1,767, a 20% drop by count. The sharpest slowdown continues to be in later stage activity, tallying only 338 rounds in the second quarter versus 548 in 2Q 2014. Depending on investor sentiment, we might see further slowdown at the Series C and D stages, or at least a leveling off if VC firms are pressured to finance future pre-IPO rounds.
For now, activity hasn’t been hit too hard at the earlier stages. Another 606 early stage financings were done in 2Q off of 608 in 1Q. We suspect early stage activity has more room to fall, however, as hiccups at the later stages will gradually ripple down the timeline. It may even hit the seed stage, which has been on an upswing* since 2012. Were it not for continued strength at the seed stage, both charts on this page would look much dourer on a counts basis. 45% of 1H 2015 activity was at the seed stage, a visible change from 37% in 2012.
In any event, 2015 will be the first yearly decline in counts since 2009. It’s worth mentioning, though, that the decline between 2008 and 2009 was somewhat mild at 10%. Investors got right back to work the following year, increasing round counts by 20% in 2010. This downswing is likely to be much more severe; the VC industry is adept at handling broader market declines like 2009, as long as they’re divorced from Silicon Valley optimism. The steeper declines come later, when valuations climb to heights that even cause optimists to pause. The venture industry has a hard time disciplining itself, in other words, until it’s too late.
But investors do make adjustments, as the chart to the right shows. As valuations have crept up, VC firms have stopped taking smaller stakes in their investments as of late. With the exception of seed rounds, the median percentage acquired at every stage had declined significantly between 2006 and 2014. The typical Series A round before 2007 used to command a median 35% stake for startups. The 2014 median was just 26%. Stakes at the later stages saw similar declines, but the medians for Series C and D rounds ticked up a bit in 1H 2015. Assuming the markets remain this unpredictable, we should see investor stakes increase across the board as VC firms gain more control over their deal flow.
See full report below.
