What’s Actually Going On With VC Valuations by PitchBook
Adding nuance to VC narratives
In the wake of our other venture-focused reports, this report poses an intriguing challenge: How best to analyze ongoing themes that have already been established and discussed, in light of the far more detailed datasets now available?
The best solution to this quandary remains, as ever, in detailing the nuances of such narratives, paying heed to the resulting modifications and acknowledging further layers of complexity. This report offers a rich display of venture capital valuations data, broken down by series, sector and more, to complement our typical datasets of financing activity. In addition, it revisits the topic of hedge and mutual fund participation in venture rounds, delving into the latest statistics on such involvement. Peppered in amongst updated data are also fresh, relevant sets of numbers, such as a look at the number of venture-backed companies that exited at valuations less than those of their immediately prior round of financing. In addition, we have a brand-new section focused upon trends in liquidation participation, which contains data on the proportion of non-participating preferred versus participating by stock series over time.
In short, this is our most expansive VC Valuations Report yet, and we hope it aids you as you conduct your own analysis of current market trends. If you have any questions or comments, feel free to reach out to us at [email protected]
GARRETT JAMES BLACK
VC Valuations – The new normal
Taking stock of the venture landscape as the midpoint of the year recedes into the past, it’s undeniable that there has been a reset. Not a reset to an extent matching the overwrought tenor of discussion seen in February when tech stocks plunged, or even the grim, foreboding warnings of how overvalued many unicorns were, but one of moderation. The crux of the matter is the rate of the reset. Has it ground to a halt or is it still progressing slowly?
Venture investors have significantly dialed back their pace, with early-stage activity diminishing considerably still. Jitters around the actual health of the US economy remain in place—however reasonably—given August’s jobs report and a volatile political climate.
Those fears have contributed to more assiduous assessment of companies’ resilience, while an even shakier global growth rate complicates matters for mature venture-backed enterprises looking to expand operations and customer bases overseas.
On top of macroeconomic factors, the late-stage phenomenon wherein mature companies stay private and round sizes plus valuations remain persistently high is by and large still present. To recap conclusions from prior reports, such a late-stage focus is to be expected in a capital-rich environment marked by uncertainty, with investors doubling down when justifiable. More detailed analysis and breakdowns of valuations data are in later sections, but the overall figures below underline those initial points well. In addition, the climate hasn’t affected financing terms too much, judging by the fact median percentages acquired have flatlined in some cases and inched upward incrementally otherwise.
So has the reset paused? No. The reset is ongoing, in a pace that is typical of private investment markets. Given their relative opacity, private markets as a matter of course absorb information and respond more slowly than their public counterparts. VC cycles are no different.
In a persistently low-real growth environment after a boom period for venture investment and liquidity, money will still pour into the coffers of VC firms until they cease to outperform safer alternatives.
On a private market timeline, the charts to the left give rise to both optimism and caution. Taking the trends with a grain of salt due to small sample sizes, last year did see an elevated number of companies exit at values lower than their prior financing, speaking to concerns about overblown valuations that deflate upon closer scrutiny by public market investors or corporate acquirers. At the same time, for those companies that were preparing to exit, median financing sizes hit a median of $7.6 million in the first seven months of 2016, an all-time high. Furthermore, valuations close to liquidity events remain historically high.
Such exit rates, particularly in light of heavy hype around tech M&A, elucidate the status of the VC reset quite well. In short, since some companies are still able to exit at decent multiples for their investors but overall selling activity is declining, with a few notable misfires, VCs are hard-pressed to balance their hoards of capital with potentially lengthening liquidity timelines, wondering how to maintain the elevated returns recently posted. As the recent debate around Andreessen Horowitz’s rate of return illustrates, what actually are good returns may in the end be best judged by whether limited partners recommit. In current public markets roiled by volatility even as they roll higher and higher, what VC fund managers need to return to please LPs may not be as high as once thought. On the other hand, such vast sums have been invested that a fair number of hefty exits are needed. Thus, bringing the rumored tech M&A boom to fruition or sustained healthy activity in that sector—which looks set to continue given corporates’ incentives—will remain the deciding factor. And that, in turn, is what will shift the pace of the ongoing reset in the venture industry. Until then, it will continue to grind slowly into a subdued, uneasy equilibrium.
After concerns of a valuation bubble in the venture industry caused fear and potentially some panic across the venture landscape at the end of 2015 and the beginning of this year, the median valuation data from 2016 lends to a slightly different narrative of what has actually happened. It’s true that completed financings and exits have slowed, as investors have revamped their investment criteria and taken a breather after a voracious couple years of dealmaking, but amid these industry changes, valuations have generally held steady through the first eight months of the year, with continued growth coming in Series C and Series D+ rounds.
While this may come as a surprise to some, there are several factors that have led to the sustained high levels of company values. Looking especially at the early stage, investors have taken the recent bubble talk to heart and shifted their tactics for investments. Demonstrated success in the form of revenues and users is becoming more and more a focal point in the search for deals, in turn leading to investments in well-developed companies worthy of a higher valuation. There is also no shortage of capital available for deployment, as commitments to funds have hit historical highs during 2016. The excess levels of capital in funds may have caused the beginning of the perceived “valuation bubble,” but they are actually being put to work in the form of larger deals in sounder companies. The split in quality of companies that had received funding in previous years is being exposed, and the companies able to hit higher benchmarks are reaping the benefits. The past few years had cultivated an ecosystem that prioritized growth over other fundamentals, but that industry mindset seems to be shifting.
Investors contend at fragmented seed stage
Seed valuations and trends
By far the largest fall in deal count this year has happened at the seed stage, as investors show significant restraint after several years of exuberant investment—more than 11,000 angel/seed deals had been completed between 2014 and 2015. The slow pace of investment hasn’t had much an effect on valuations, however, as seed-stage median premoney valuations are up within nearly all industries. The seed stage is very competitive currently, owing much to the rise in the number of institutional investors and funds targeting the stage in recent years. The specialization of such funds, and accompanying industry insight and business acumen, have allowed seeds to move further into a startup’s lifecycle, making the “seed is the new Series A” cliche all the more true. Often referred to as micro VCs, these seed firms are now an integral part of this new venture lifecycle. As early-stage investors seek out startups with more traction and better unit economics, micro VCs have been tasked with readying their portfolio companies to hit these more taxing benchmarks set by later investors.
Seeds are very often not the first institutional money to reach a startup now, whereas in the past a seed might enter soon after a startup raised a small sum from family or angels, the rise of accelerators and pre-seed investors has pushed traditional seed investments down the lifecycle. All in all, the median seed investment size rose to $1.5 million through August 1, 2016—up $500,000 from the 2015 median—while the median seed valuation hit $5.9 million, a jump of $2 million from 2012.
Series A financings remain a crossroads
Series A valuations and trends
The Series A narrative is similar to that of the seed stage. The growth in seed activity has also partially pushed Series A deals into a time range that was previously held by early Series B deals, generating heightened expectations. Through the first eight months of 2016, Series A pre-money valuations have held at a median of just over $14 million, which, while technically showing no growth over 2015, is $2 million higher than in 2014 and almost double the median Series A valuation attained five years ago. For all intents and purposes, the Series A stage has come to a crossroads.
As investors in the stage slow down the overall investment pace, since the number of companies receiving seeds hit an all-time high in 2014 and 2015, they will need to decide how to proceed with startups that haven’t yet had enough time to hit the key performance indicators (KPIs) they are looking for. Record seed activity should lead to more Series A deals being completed, however, a certain Series A bottleneck has evolved, though not due to a lack of capital available to be deployed. Investors are more unwilling to invest in unproven businesses, setting high goals for revenues and other KPIs that for many startups are unattainable early in their business cycle. In many cases, the timeline to reach these expectations has simply lengthened. Those that have been able to secure a Series A follow-on round were rewarded handsomely, however. Through the start of August 2016, 59 Series A rounds of $20 million or more have been closed in the US, 16 of which generated pre-money valuations of at least $50 million.
More competition for still significant sums
Series B valuations and trends
Amidst a venture environment pervaded with robust amounts of capital and public market comparables’ hitting near historic highs, in recent years we have seen Series B round sizes reach considerable heights. After raising more than $88 billion in 2014 and 2015, investors entered 2016 equipped with large vehicles; however, in wake of recent volatility in the global markets, investors slowed activity quite considerably. VCs prudently searched for companies that either offered the financial strength to further their product development and expansion in upcoming quarters—common objectives at the Series B stage—or presented a prospective liquidity opportunity. Early-stage pharma and biotech companies offered potential for the liquidity sought by VCs, and were compensated with financings over 36% larger in size than the year before; however, founders had to give up significantly more equity as a result.
Since pharma and biotech comprised the majority of IPOs this year, the greater proportions doled out to VC firms coupled with less-diluted equity pools means investors could reap more benefits in upcoming quarters if they have not already. Regardless of the excess capital pharma and biotech have raised, valuations have declined, with the only immune sector being commercial services, which experienced a valuation uptick of 27% from 2015. This is in part attributable to sector-wide integration of workplace automation technologies, providing commercial businesses with the opportunity to cut expenditures in capacities such as client resource management, human resources, and marketing. As evidenced by the uptick in median percentage acquired from 28.6% to 34.4% in pharma and biotech and 20.8% to 22.0% in software, the competition for VC dollars is intensifying. Founders in certain segments pursuing Series B financing should prepare to spend more time justifying rounds and valuations of such size, and brace for more balanced negotiations, as opposed to the overtly founder-friendly climate that reigned in the past.
The inflection point may shift downward for some
Series C valuations and trends
Beginning the year, the private markets began to see valuations plateau in early-stage tranches— though such recalibration is just beginning to infiltrate the Series C stage. Since the end of 2015, volatility in financial markets has left many wondering whether outside pricing pressure and overstretched valuations are finally coming home to roost, and perhaps subject to fall even further as macroeconomic factors weigh on global markets. In response, many founders were obliged to evaluate whether they had the infrastructure to withstand a potential economic downturn. The greater majority of players that recommenced campaigning for Series C funds were in the software sector, given the currently prevalent composition of late-stage startups. As evidenced by the 30.9% increase in deal size across all sectors, investors have still been hungry for quality opportunities and did not shy away from deploying capital into companies which displayed impressive growth metrics backed by actual revenues; however, the environment differed from years prior, with investors exercising greater degrees of due diligence. For companies like DoorDash that simply didn’t display robust enough metrics, valuations were trimmed.
As Series C financings often represent an inflection point, where companies position to scale, potentially make acquisitions, and begin advancing their potential strategies to completing a liquidity event, those with less-than-stellar ingredients that are looking to play a long game may see a higher probability of down rounds in future financings as investors continue to exhibit higher standards. Already we have observed 19 down rounds through the start of August 2016, as opposed to 17 in 2015—that 19 figure is more than what 2015 saw in its entirety.
The late-stage field adapts to the current environment
Series D and later valuations and trends
Late-stage investment activity was nothing short of robust last year, as the absence of fear in Silicon Valley coupled with increased competition in the venture market led to an unceasing spurt of capital. In contrast, Series D activity in 2016 has seen a considerable decline. Yet all the while, valuations have continued to climb, up 101% since 2013. While a valuation uptick of such magnitude is generally
greeted with an according increase in deal size, we are seeing the spread between the two widen, as companies entering Series D and later stages have started utilizing instruments outside of the realm of traditional VC. Averaging a mature age of 9.1 years, companies at this stage have less equity to offer new investors, but as they are forced to maintain higher burn rates in order to expand and gain market share, we’ve seen some companies turn to the debt markets.
As late-stage companies continue to wait out the exit environment, we will likely see cash-flow-positive businesses continue to employ debt instruments as a means of avoiding further dilution while simultaneously constructing relationships with banks that they may want to use as service providers upon exit. In addition, turning to the debt markets also allows creditors to become familiar with these typically opaque businesses and potentially establish a relationship that could contribute to greater comfort with further financings down the road. These initiatives can forestall trepidation around liquidity prospects for investors that entered around late stages, even if they have negotiated sufficient downside protection. For earlier investors with more pressing liquidity concerns, secondary markets or aforementioned financing rounds could provide some relief.
Incentives to stay active
Corporate, hedge & mutual fund participation
Capitalizing upon the growth opportunities offered in the venture market, mutual and hedge funds have deployed massive amounts of capital into late-stage companies over recent years, securing toe-holds for eventual IPOs whilst gleaning general tech insights that could be helpful in researching publicly listed counterparts. However, amid a softening capital market and uncertain geopolitical conditions, hedge fund managers have reduced the amount of capital deployed in the market, only having invested $3.4 billion so far this year as opposed to the lofty $8.3 billion in 2015. As volatility across multiple asset classes has induced increased redemptions for hedge fund investors, such managers need to remain relatively liquid in order to satisfy potential future redemptions without being forced to sell other successful fund assets.
Meanwhile, mutual fund participation in recent years has introduced an interesting dynamic to the venture market, as daily mark-to-market accounting requires funds to mark down private valuations when public comparables decline on the day— leaving private companies’ valuations exposed to the public market in a way that they never have been before. However, mutual fund managers have backed off only slightly in terms of activity and the median round size is still up 123% from that of 2013.
As mutual and hedge funds alike depend on a lively IPO market to cash in on their private company investments, we may see an increase in nontraditional activity if the IPO window begins to creep open. That said, examples such as Twilio and Line represent outliers in the market, and while we think that a few quality companies will undergo successful listings in what remains of 2016, we don’t anticipate new offerings coming to market at a heightened clip.
In an uncertain environment, nontraditional investors must prioritize core short-term allocations and liquidity and extended due diligence into opaque private companies. While new hedge fund investment appears to be stalling, as mentioned, mutual fund managers have moved forward with no less than $11.5 billion invested into the asset class thus far in 2016, relative to $14.2 billion in 2015. Even if round counts have declined, the dollar totals speak volumes.
While mutual and hedge funds were unable to maintain prior levels of activity in the venture sphere due to illiquidity risks, the investment theses of corporate venture capital arms liberates them from being directly tied to the public markets, which was reflected in their ability to maintain an impressive pace of investment activity during the first half of the year. In recent years, corporations have embraced innovation in ways unseen before, heavily capitalizing upon new technologies’ ability to advance platform businesses and provide a shield of defense from marginalization in the marketplace. As groundbreaking disrupters are more and more apparent, corporations have fought tooth and nail over the opportunity to be the earliest of their kind to successfully integrate their product offering with innovative technology critical to the viability of an emerging ecosystem. Moving countercyclically to traditional venture firms, interestingly, late-stage valuations of rounds with corporate VC participation plummeted by 23.8% from 2015 into 2016.
Marked by caution
Valuation step-ups, changes and time between rounds
During the first eight months of 2016, a gloomy narrative around the rising percentage of down rounds in venture capital has emerged, fueled by the belief a valuation bubble was the sole cause of the venture capital reset. What that narrative overstates is the proportion of down rounds when compared to any year other than 2014 or 2015, as 2016 currently stands with the third lowest proportion of down rounds for any given year during the past decade. Down rounds have risen by only 1% of total completed deals YoY. Also missing in much of similar analyses is the rise in proportion of up
rounds this year. 76% of VC financings have received a higher valuation than the company’s previous round; the occurrence of flat rounds has been compressed to roughly 11%. Software
companies are even seeing 81% up rounds, the highest percentage observed in the past five years. The likely cause for the bump in up rounds is increased investor diligence, as refocusing initiatives gain steam across the industry. If companies are gaining more traction before a certain investment round, that round size should go up, along with the round’s valuation.
To be fair, the median valuation stepups for both early-stage and late-stage companies have fallen back from 2015 highs, but on a historical basis they have held strong. Early and late-stage deals fell back to 1.6x and 1.3x step-up multiples, slides of just 0.2x and 0.1x respectively. Investors are still finding quality opportunities to put their capital to work, and they are writing larger checks when they do. As earlystage companies continue to rake in valuation step-ups of that magnitude, it’s easy to see that a crash hasn’t happened as predicted. Compare the 0.2x early-stage drop this year to the 0.5x fall in 2009 and all worries of a massive fall should dissipate in the short term.
VC-backed companies have had to change their spending habits, however, as the burn rates seen over the past couple years were unsustainable for the long term. The time between rounds has been lengthened at every stage in the VC lifecycle, so accordingly, companies are looking for ways to become more efficient to make their cash last longer. For some companies today experiencing dire straits, slashing headcount is a method of last resort to reduce expenses. 2016 has been rife with companies at all stages making cuts to their workforce, most notably Reddit and Zenefits. All in all, it seems to be a refocus by the entire industry and, in a way, a reemphasis on the basics.
Over the past three years, there has been a distinct decline in the proportion of participating stock in venture financings across all series. Most striking at later stages, the diminution clearly aligns with a longrecognized trend toward founderfriendly financing terms, reinforced by the slow decline in the median percentage acquired established above. However, the leveling out of the decline in both the median percentage acquired and participation signals that the balance of power between investors and founders continues to equalize in the current climate. Granted, some exceptions remain, as in the significant drop between the 35.6% observed in 2015 and the subsequent 24.2% notched in 2016 through the start of August by Series B rounds, but by and large, the equilibrium is resetting.
Participating versus non-participating can be a hotly debated topic. Participating arrangements can quickly spiral into mathematical complexity, but in essence, non-participating is viewed more favorably by founders/entrepreneurs and, in a healthy exit environment, investors are willing to take the potential upside as they will get their preferred return back at the very least. (The shrinking incidence of capped participation testifies to how founders view the feature overall with some discontent, as the cap is essentially an agreed-upon limit on the proceeds for an investor, but can quickly lead to funders receiving the same amount even if the outcomes are poor or midsized.)
What becomes more interesting is what may happen as the exit environment either remains sluggish or resurges. Combined with the surplus of VC raised and waiting to be invested, a mildly different dynamic could or likely has already emerged wherein non-participating remains the majority but plateaus proportionally, as in some cases investors command somewhat more favorable terms in the form of more frequent participation, if they expect a less welcoming exit environment.
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