Key Highlights:
- Significant VC availability is allowing companies to forgo traditional exit timelines
- Startups are raising later, waiting until a median 2.4 years after founding before raising angel/seed rounds
- Though 3Q was slow, 2017 is likely to be the fourth consecutive year with $30 billion+ in commitments
Executive Summary
Nearly 1,700 US venture-backed companies raised $21.5 billion in funding in the third quarter of 2017 to build and grow their innovative businesses, bringing the year-to-date total to 5,811 companies raising $61.4 billion. After an uptick in venture capital (VC) investment activity in the first two quarters, the industry witnessed a downturn in 3Q in both capital deployed and the number of companies receiving VC funding. If this pace holds through year-end, full-year 2017 VC dollars invested are on track to be the highest in the past decade, while the number of VC deals completed in 2017 may be the lowest annual total since 2012.
At the surface, capital invested into startups in 2017 uncovers the impact unicorns have had on VC, as investments into these companies valued at $1 billion+ continue to inflate deal value and valuations for later-stage financings and can skew the underlying trends. Though these late-stage mega-rounds represent a new normal in the VC market, excluding these investments depicts deal value aligning more closely with the drop in deal count, unveiling a contraction and compression in the market where fewer companies are receiving funding but with more capital.
A closer look at investment data also shows that after the burst of dollars mutual funds and hedge funds deployed into VC-backed companies in 2014, 2015 and 2016, their recent retraction has coincided with other nontraditional investors —notably sovereign wealth funds and SoftBank’s $100 billion Vision Fund—taking positions in venture-backed companies. SoftBank’s 3Q investments included a $3 billion funding round in WeWork, the largest deal of the quarter, which alone accounted for 17% of overall investment into VC-backed companies.
Nontraditional investors taking positions in VC-backed companies has also translated into opportunities for secondary private investments. This comes as the optimism surrounding the IPO market at the beginning of 2017 has waned, particularly as 3Q saw only eight venture-backed offerings. With these exits tapering and M&A activity slowing down, private equity firms have stepped in as a more popular source of liquidity. The challenging IPO environment for VC-backed companies emphasizes the longer-term trend and need for capital markets reform, an issue that NVCA continues to advocate for on behalf of the venture ecosystem.
As the number of companies receiving VC funding and VC-backed IPOs dipped in 3Q, the number of VC funds holding a final close also dropped to its lowest quarterly level in the past five years. VC firms closed on $5.3 billion across 34 funds in 3Q, which comes after a strong fundraising quarter in 2Q led by a $3.3 billion final close for New Enterprise Associates 16, bringing total fundraising year-to-date to $24.4 billion. The decline in 3Q fundraising is not surprising given the cyclical nature of fundraising and the large amount of fresh funds raised in recent quarters. First-time funds continued their run toward a strong year, with $2.4 billion raised across 25 first-time funds year-to-date, on pace for the highest annual capital raised in the past decade.
One of the biggest industry trends making headlines in 3Q has been the rise of initial coin offerings, or ICOs. The process enables companies to raise capital directly from early adopters by selling cryptocurrency tokens. Though generating buzz, the sustainability of these investments remains questionable given limited opportunity for due diligence, no working product in most cases and thinly traded secondary markets creating significant mark-to-market volatility. Whether venture investors embrace this alternative form of investing or remain skeptical, the fact remains that more than 140 ICOs have raised over $2.2 billion so far this year, according to CoinSchedule.
Also making headlines has been the recent lawsuit filed by NVCA, entrepreneurs and startups against the Department of Homeland Security (DHS) challenging the agency’s delay of the International Entrepreneur Rule (IER). Finalized by the Obama Administration, the rule would have allowed talented foreign-born entrepreneurs to travel to or stay in the US to grow their companies. Less than a week before the IER was to go into effect on July 17, DHS announced that the rule would be delayed and that DHS will be proposing to rescind the final rule. Because DHS did not solicit advance comment from the public on the delay, it violated clear requirements of the Administrative Procedure Act.
Finally, this edition of the PitchBook-NVCA Venture Monitor marks the one-year anniversary of the report and the PitchBook-NVCA partnership. Thank you for helping to make this publication the go-to resource for quarterly VC data. We welcome your feedback as we continue to shape this report to provide meaningful insights to you, our readers.
Overview
Three quarters into the year, 2017 is on pace to set a decade-high record in terms of total VC invested. Despite the average quarterly deal value figure through the year coming in at more than $20 billion, total deal count is set to decline for the third consecutive year. To date, just 5,948 deals have been completed, which represents an 11% YoY decline relative to the same period last year. This divergence comes as the industry continues to transition, putting more capital into fewer deals and working toward growth that couples traditional KPIs with the hockey stick user growth that VC demands. In spite of industry reservations concerning the sustainability of how large rounds have become in recent years, deal sizes have continued to grow across all stages, bolstered by record fundraising levels and a high amount of dry powder. Further, not only are round sizes increasing, but these rounds are being raised later in companies’ lifecycles, in turn prolonging the time to exit for many businesses.
In recent quarters, the decline in aggregate VC deal flow closely mirrors the explicit decline we’ve seen in the angel & seed market. So far this year, angel & seed investments represent less than 50% of all completed deals for the first time since 2012, the culmination of quarter-over- quarter declines in seven of the past 10 quarters. But rather than investors shying away from funding companies, the declines are in large part due to how seed deals have moved further into the venture lifecycle. The median age of companies raising an angel or seed round has moved to 2.4 years, almost a full year older than just six years ago. While investors in venture’s earliest stage have ushered in the era of increased activity, the maturation of the stage has inspired more discipline in capital deployment. As these investors have sought companies with more traction, deals have naturally moved larger and later. In addition, the median angel & seed deal surpassed $1 million in size for the first time in the past decade. The early and late stages have made similar transformations. “Series A is the new Series B” comments are not only becoming more common, but may have more legs to stand on. In fact, year-to-date, the median
early-stage deal size of $6.1 million has surpassed the median late-stage deal size of 2010—$6 million—another VC “first” that has been recorded this year.
But that movement can only explain part of the transition we continue to see the venture industry move through. Companies continue to remain private and delay exits as they are able to raise late-stage capital in the private markets. The last two quarters mark just the second time in the past decade that more than $20 billion was invested in two consecutive terms, and the total raised during that time is the highest we have seen in a such a timespan. What is often overlooked is just how much that figure is the product of the enormous rounds that have become the new normal: WeWork raised a total of $4.4 billion last quarter, with $3 billion of that invested in its US operations; Airbnb raised a $1 billion round in 2Q; and five other companies in the US have raised rounds of at least $500 million in 2017. In fact, deals that carry a valuation of $1 billion or more represent less than 1% of 2017 deal count but account for nearly 22% of the aggregate deal value year-to-date. As these companies continue to raise private rounds, investors increase exposure to market and liquidity risks that could threaten their eventual ROI—there is currently more than $575 billion in value locked up in companies valued at over $1 billion. These unicorn private rounds have seemingly come at the expense of traditional return timelines. The average time to exit has grown to 6.2 years, with the median pushing past five years for the first time in the past decade. IPOs, which could be a more suitable exit route for companies with valuations that may be tough to stomach for both strategic and financial buyers, have lagged over the past few years. IPOs of companies valued at less than $500 million have fallen by the wayside—just 18 US IPOs in 2017 were completed by companies valued at or above $500 million. For reference, 92 such offerings were completed just three years ago in 2014.
It is likely these trends will continue for at least the near term. The extension of exit timelines will perpetuate as US VC investors have more dry powder ($92 billion) than any time in the past decade, and many mega-funds remain within their investment periods. While SoftBank’s Vision Fund and other nontraditional investors will continue to provide capital to late-stage companies, we think PE-backed buyouts will continue to account for a larger group of VC-backed exits. PE players have already increased the amount they invest in software businesses, and, given the makeup of many VC-backed SaaS businesses, we have confidence this trend will continue to bridge the gap between PE and VC.
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