Venture Capital Liquidity: Will A Reset Encourage Selling? by PitchBook
Taking the pulse of the venture capital market as we pass through March produces some decidedly mixed signals. It’s undeniable that there has been a significant shift in investor expectations, with warnings for portfolio companies to tighten their belts abounding, while others counsel new startups about how to raise capital in the current, wary environment. Yet no analysis of the overall venture landscape is complete without examining venture capital-backed exit activity. Last year exhibited historically strong numbers across North America and Europe–from which all datasets in this report are drawn unless otherwise noted–yet quarterly activity reveals a distinct deflation of momentum, if not yet of value. Such a slide was to be expected, given how last year closed, with the IPO window squeezing nearly shut and corporate acquirers likely pulling back to at least some degree, waiting to assess general economic conditions. But what is unclear, as of yet, is whether that decline is set to intensify, producing significant liquidity issues for venture sellers across the board, or whether activity will plateau at a lower level than the heady heights seen in the past few years.
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In the following pages we delve more deeply into that question, examining trends in venture capital-backed exits through a variety of lenses, such as corporate buys, private markets and more. A note about the segment produced in collaboration with Nasdaq–the datasets within that feature are drawn from Nasdaq Private Market Private Company Liquidity: A Year in Review, with the accompanying interview and additional analysis further reinforced by the conclusions within that report.
Garrett James Black
Venture Capital Liquidity: Is The Cycle Shifting?
Amid alarmist headlines or proclamations that the venture capital industry’s recalibration will only be mild, it’s important to bear in mind that last year still saw the second-most exits for the second-highest total in value for the decade. In short, even if both metrics were down from the peak of 2014, corporate buyers in particular were still willing to pay elevated prices for the right targets. As quarterly exit flow reveals, there has been a distinct slackening in momentum, indicative of increased caution on the part of prospective buyers and public market investors. This shift in the cycle will likely take some time to work out, particularly as the extent of the reset in valuations and round sizes remains to be seen.
When it comes to general concerns around liquidity and that ongoing reset for the VCs that have participated in the boom of the past years, most of them are centered on the late stage. Fears seesaw between the viability of tech giants shelling out hundreds of millions for older, highly valued companies to the resuscitation of the IPO market. As the numbers below reveal, the former remains by far the most crucial source of liquidity. After all, corporate acquisitions accounted for 72% of all 2015 exit value and 78% of all exit activity. The IPO market, it should be noted, remains important, particularly for the herd of unicorns whose valuations would give even strategics with deep pockets pause. But for the majority of venture capital-backed startups, how much longer the boom in M&A will persist is the primary concern. This is where venture-backed liquidity becomes most directly related to wider economic trends. Wary of even greater turmoil or a harsher downturn, venture investors may well look to sell off some holdings, particularly if they have been unable to achieve liquidity in private markets and fund timelines are running long.
Others, wondering how public markets and strategic buyers will greet startups, will hold off. There are signs, especially in the U.S., that fears may be abating a tad, which could encourage both buyers and sellers to take action before things potentially take a turn for the worse. Other important factors to consider include potential increases in usage of secondary markets, even if size is a potentially limiting factor therein for companies on the larger end. Exit prospects for unicorns will be difficult to assess until more time passes, although, as we discuss later, even for unicorns there may be some mitigating factors. Overall, whether or not fears of an economic slowdown are realized–which could only further drive valuations down, encouraging buyers–there is plenty of impetus to propel a healthy if subdued level of venture capital-backed selling. It’s likely exit values will slide somewhat, given a potential recalibration of seller expectations regarding valuation in an environment marked by uncertainty, but the rate of selling should stabilize at a lower level. It’s worth stressing two things: The nontraditional venture investors that contributed to late-stage exuberance have different liquidity timelines, which could yield some intriguing results in the year to come; and, in contrast, traditional VCs that had to invest heavily at even early stages recently will wait continued tumult out, having the luxury of some time before liquidity becomes a pressing concern, and consequently opting for a more opportune exit time.
A Slew Of Big Exits
Exits by size
The last two years have seen more exits valued at $500 million or above than any other comparable period. Across North America and Europe, 62 sales in that size range occurred from 2014 to 2015, outstripping the four previous years combined. Such a slew of lucrative exits is indicative of not only the recent high tide of M&A but also the ramp-up in venture capital valuations. $23 billion in total exit value achieved in that size range doesn’t happen without fierce demand as well as some price inflation. Corporate and financial buyers remained quite active at the lower end as well, with the 83 sales closed last year in the $25 million to $50 million range marking the highest tally since 2007.
What’s worth remarking, however, is the stark drop in mid-range exits. 88 sales in the $50 million to $100 million range closed in 2015, a stark drop from the 124 observed in 2014. That figure is still on the higher end, but the sudden decline could, perhaps, indicate a slump in the middle of the exit market until larger venture capital-backed companies experience a reset in valuations and become attractive targets once within that size range. As evidenced by GM’s recent purchase of Cruise, corporate buyers will still pay large sums for even young startups when justifiable, while acquisitions at the lower end will, of course, remain numerous, particularly as micro funds may consolidate. Yet many of the most attractive targets valued in that price range have likely been acquired already, in the rash of selling over the past couple years. If a significant recalibration of valuations for certain companies occurs, perhaps sales within that portion of the market could resurge.
Pharma & Biotech To Remain Healthy?
Exits by sector
Software retained a commanding proportion of overall exit activity, accounting for 35% in 2015. It’s worthwhile noting, however, that even if each sector’s relative proportion has not seemed to shift much, consumer goods & recreation, as well as IT hardware, were the only two segments to see slight increases in exit activity between 2014 and 2015. Whether or not that is a fluke of sorts, the fact consumer goods & recreation reached a record for the decade could indicate how corporate acquirers are snapping up e-commerce startups with innovative platforms, in the oftremarked trend of using M&A as a substitute for R&D–witness Yahoo’s acquisition of Polyvore, for example. Such startups aren’t going for much relative to other sectors, however; software and pharma & biotech companies still account for a clear majority of exit value.
In fact, the latter category saw a massive $16.3 billion in total value of all exits, reflective of its tally of 123 total liquidity events, second-highest of the decade. It’s hard to tell when, precisely, the acquisitive pace of pharma giants such as Bristol Myers-Squibb, which bought Flexus Biosciences for a handsome sum last year, will slack, given patent portfolio changes. The hammering biotech stocks took in the onset of the year could, even if a mild, bearish rally occurs, lead to private biotechs’ valuations dropping, rendering them more attractive to strategic buyers. Perhaps selling within the sector will remain strong, even throughout 2016, accordingly.
Activity Stays Strong
Exits by region
Last year saw venture capital-backed sales remain at an elevated level, across both North America and Europe.
Keeping It Private
Exit time metrics
The trend of staying private longer has almost become a trope at this point, contributing as it has to the disparity between venture investment and exits. Breaking down that trend lends further insight into exit timelines, revealing as it does how long the stay-private trend has been going on. Through 2015, the median time between going public and first venture capital financing stayed steady at 6.6 years, while the acquisition/buyout counterpart remained similarly stable. That heightened figure for IPOs in particular makes sense, as late-stage companies stayed private longer and longer, until the need for liquidity and ampler sources of capital grew pressing.
In addition, at a certain stage of growth, the incentive to stay private fades. It’s interesting to note that the upper bound of that duration has seemed to be between six or seven years for some time now. The slight dip in time between founding and exiting via IPO, on the other hand, is likely owing more to the spate of offerings that kicked off 2015, before the IPO market dried up. But of all the metrics on this page, the most interesting–and dramatically changeable–has been the plunge in the time between last venture capital financing and exit via IPO. The drop in that metric to a remarkably short seven months is due in no small part to the abundance of capital available to late-stage companies poised to go public. Before unease rippled throughout public and venture capital markets alike, nontraditional venture investors were eager to inject capital into companies preparing to go public only a little later, while the latter were more than willing to accept more fuel for rapid growth. Investors anticipated potential surges in valuations even by public markets, so optimistic was the general mood.