2016 was a year of change for the US venture industry. Talk of a valuation bubble proliferated before the year even began; venture-backed IPO activity was the lowest since the financial crisis; VC invested in late-stage rounds continued to pile up even as activity fell; and fundraising continued apace. So, as we take stock in the first few days of 2017, is the venture market healthy?
In the 4Q 2016 PitchBook-NVCA Venture Monitor, we break down exactly why that is and how seemingly contradictory venture trends actually reveal a more complex narrative of how the US venture ecosystem was transformed last year. Produced in partnership with the National Venture Capital Association, the Venture Monitor features multiple datasets, including:
- Deal, exit and fundraising activity by year and quarter
- Breakdowns by sector, size and stage
- Corporate VC and growth equity activity
- Extended 4Q league tables of top deals, funds and exits, as well as breakdowns of activity by metropolitan area and congressional district
Through the first half of 2016, venture investment activity in the US seemingly continued the frenetic pace of 2015, which was a headline year for the industry. However, a slowdown in VC investment activity began in the third quarter that continued into the fourth quarter when just $12.7 billion was deployed to 1,736 companies. Nonetheless, 2016 ended with a total of $69.1 billion invested into the US venture ecosystem, representing the second highest annual total—after 2015—in the past 11 years. More than 7,350 companies raised capital across 8,136 deals in 2016, with both measures reverting toward 2012 annual levels.
The decrease in 2016 venture investment activity was somewhat expected, given the high activity levels reached in late 2014 and 2015. Driven by an updraft in valuations, the number of deals during this period escalated, creating indigestion in the marketplace for some. As a result, 2016 represented less of a slowdown and more of a return to normalization. Venture investors are now circling back to tried and true ways of deploying capital and being much more critical of their investment options. Going into 2017, the question remains whether venture investment activity has plateaued, or if it will continue to downshift.
It was against this backdrop of a return to normalcy that the venture industry notched its best fundraising year of the past decade in 2016. Each quarter of 2016 saw strong fundraising totals, with the $13.6 billion raised during the second quarter being the standout. In the fourth quarter, venture investors raised $7.3 billion across 50 funds, bringing the annual total to $41.6 billion raised across 253 funds.
Despite the 10-year high for capital raised by venture funds, the total number of funds closed in 2016 declined slightly for the second straight year. The cyclical nature of venture capital fundraising, evidenced by a number of larger venture firms coming back to market and closing $1 billion+ funds, coincided with more capital being managed by fewer funds, leading to an increasing concentration of capital in the industry. Seven firms raised $1 billion+ venture funds in 2016, accounting for more than 23% of the total capital raised. Given how strong fundraising was in 2016, it will be telling to see how the fundraising environment shakes out in 2017, especially for smaller funds and new managers who may encounter a challenging climate.
In the face of a strong year for fundraising, the exit environment remained a challenge. Corporate acquisitions continued to account for the largest proportion of venture-backed liquidity events in 2016, and the IPO window remained narrow for venture-backed companies. In the fourth quarter, seven venture-backed companies went public, bringing the total for the year to 39, which is half the number of IPOs from 2015 and the lowest completed since 2009, when there were only 10 venture-backed IPOs in the wake of the financial crisis.
Looking to 2017, there is widespread hope that the IPO market will finally thaw. With around 20 venture-backed companies currently in IPO registration, there is optimism for a strong 2017. Though the quantity and quality of companies in the pipeline remains high, the execution of those IPOs may pose a challenge, especially for companies that have valuations that might not be easily supported in the public markets. While there is optimism for a strong year of IPO activity, M&A activity will likely remain robust with plenty of cash on corporate balance sheets and expectations of a Republican-controlled Washington fulfilling its pledge to reform the corporate tax code.
In spite of the slowdown in venture investment activity in the second half of 2016 and questions surrounding the IPO environment for venture-backed companies, there remains much to be optimistic about in 2017. Venture investors will continue to invest in and unlock new innovations that will transform our society and strengthen our economy. Many venture investors forecast 2017 being categorized as “the rise of the machine” with an increased emphasis on investment in artificial intelligence, robotics, drones and machine learning. In fact, many investors will increasingly experiment in “exploratory sectors” to determine what trends they can learn from, as they realize that to make interesting, disruptive investments, they need to look beyond what they are already doing.
Venture Investment Activity
The 2016 venture environment remained relatively healthy. Deal count and aggregate transaction value for the year did decline from the numbers seen over the previous two years, but whereas the froth in 2014 and 2015 were forged by mega-rounds and new unicorns, 2016 saw investment pace return to a more manageable level, yet private valuations certainly didn’t decrease. Deal sizes grew or stayed flat across the board during the year keeping deal value high on a relative basis, however, excessive fundings were few and far between—there were 40% fewer $100 million+ rounds completed in the US during 2016 (59) than in 2015 (98). Much of the dialogue throughout the year focused on investors setting higher benchmarks for startups as the search for deals went beyond simply growth metrics and back to core fundamentals. Moreover, easy capital that was available during the past couple years became much tougher to raise, resulting in even well-funded companies looking to preserve their capital runway.
4Q marked the sixth consecutive quarter in which we saw completed VC fundings decline as activity continued its steady slide back to 2012 levels. While much of that decline can be traced to seed/angel deals, which have fallen by 665 deals (43%) during that time, no stage has been exempt from a fall in deal activity. Further, early-stage activity in 4Q came in at the lowest level since 2012, while late-stage deal count dropped to its lowest point since 2009. But where the number of deals has declined, the capital deployed into those deals, and that available to be put to work has somewhat filled the void, as investors shift toward a focus on somewhat more sustainable investment techniques.
To be fair, the venture industry has several hurdles directly in front of it. An uncertain economic environment, coupled with looming change in US trade policy is sure to have an effect on venture funding and exits, though to what extent is to be determined. Until actualization of those policies, current dynamics in the venture industry will still result in a regression to the mean.
Angel & seed stage moving through transition
Angel & seed activity in the US
2016 saw more than $6.6 billion invested across approximately 4,115 angel/seed funding rounds, reflecting noticeable year-over-year (YoY) declines of roughly 19% and 28%, respectively. On a quarterly basis, total capital invested throughout 2016 certainly remained strong relative to historical norms, yet total completed financings did drop to 2012 levels. In contrast to the decline we saw in funding activity, median angel and seed round sizes jumped approximately 11% and 50%, respectively, compared to 2015. In fact, more than 42% of all angel/ seed rounds we tracked came in at between $1 million and $5 million, the highest proportion in more than 10 years.
For the first time in at least a decade, total angel activity declined in 2016 as just over 2,500 financings were completed, a 25% YoY decline. This figure is even more notable when considering that 2015 activity in the stage had increased by roughly the same percentage over 2014. The median angel deal size moved up to $600,000 last year, while median valuation simultaneously dipped to $5.4 million.
As seed investment continues to shift further into the venture lifecycle, the median seed deal size reached its highest point of the past decade ($1.5 million), eclipsing the previous $1 million record we saw in 2015. Yet moving in the opposite direction of the angel market, valuations of seed deals continued to climb higher, reaching nearly $6 million.
Will 4Q be end of early-stage decline?
US early-stage VC activity
Following a strong early-stage deal-making environment in 2015, just shy of 2,500 rounds closed during 2016, the lowest count since 2011, with each quarter seeing a subsequent decline in activity. Given the run up in nearly every facet of the venture industry over the last couple of years, the early-stage decline represents a natural regression as investors look to maintain the bandwidth to continue supporting their existing portfolio. Fervent fundraising in 2016 also required considerable attention from managers, forcing them to explore fewer transactions. Further, the last few years have seen a wide range of new sectors—from VR to AI to IoT—that took an additional amount of scrutiny and understanding, lengthening the dealmaking process altogether. While investment activity declined across the early stage, capital invested figures remained strong at $24 billion in 2016. A heavy concentration of that figure ($11.3 billion) did, however, was in rounds of $25 million+, the highest percentage we’ve recorded over the last 10 years. With capital invested certainly concentrated around fewer deals this year, the further maturation of new industries combined with likely lower fundraising efforts could help underpin transaction volume after a few quarters of declining activity.
Several hurdles making late-stage investors sweat
US late-stage VC activity
Observably, the late stage has seen a substantial drop off in activity during 2016. Whereas the last couple years have been filled with unicorn fundings and socalled ‘private IPOs’, 2016 was much more subdued, especially toward the latter end. The median late-stage round fell slightly to $10 million, and while 2Q stands above all others from the last decade in terms of capital invested, a significant amount was generated by just two completed deals for Uber and Airbnb (Uber’s financings from the first half were combined into one large-round, according to PitchBook methodology).
The seemingly easy capital that had been available to companies for several years has somewhat dried up. A sluggish exit market has kept more capital locked away than ever before, causing some VCs to hit the pause button before making more investments. The hopeful rush of unicorns to IPO has yet to materialize, and strategic acquirers were unable to pick up the slack with acquisitions of their own, making the late stage an even more difficult arena to navigate. As growth continues to require more and more capital before an exit can be made, late-stage investors may be looking at much smaller ROIs than in the past, especially as the validity of some valuations has come under scrutiny.
Rounds by sector
Corporate venture capital
Since 2013, the number of completed VC deals involving corporate VC (CVC) hasn’t fallen below 1,000, a barrier that had yet to be exceeded this decade. CVC has continually become a popular way for corporations to invest in new technologies, either through a corporate venture arm, or simply through diverting money directly from their balance sheet. The percentage of all completed VC deals to involve CVC has grown each of the past four years, hitting 13.4% during 2016. An even more telling statistic regarding the growth of CVC, however, may be the number of active corporations during any given year, which has more than doubled since 2009 to 933 in 2016, and has grown in total number each year during that time. Intel, Google and Salesforce are a few of the well-known CVCs, but new entrants into the field this year include Campbell Soup Company, low-cost airline JetBlue and children’s programming company Sesame Street, three companies one might not expect to see making VC deals.
The pace of technological advancement over recent years has pushed corporations to find new paths for innovation. With questions surrounding economic growth, in much the same respect as corporate M&A, venture investing has provided an avenue that in many ways is more cost effective than internal R&D spent toward technology growth. Because the partnership between corporates and startups is so mutually beneficial, we would be remiss to think CVC won’t continue to grow at a similar pace.
Read the full report here.