VC Activity, Valuations & Trends – 2015 Annual Report by PitchBook
VC Activity, Valuations & Trends – The Conversation Has Changed
Introduction
Since so much has changed in the venture industry since the last installment of this report, we had to choose whether or not to use datasets from our typical timeframe, which would have been through the end of 2015, or to include data from last month. To achieve a balance, in the following report we’ve updated overall U.S. venture activity and valuations through the end of February 2016. In addition, we expanded datasets covering the impacts of corporate venture capital, hedge and mutual funds on the venture landscape, elaborating on how the increases in activity by each type of investor has helped transform VC trends of the past few years.
This revamp of the report was mainly done to better reflect exactly how the downturn in U.S. VC activity over the past several months has affected overall valuations. It’s clear the conversation has changed, at the behest of macroeconomic concerns and volatility in public equity markets. Especially as things have taken a turn for the better in recent days, however, in what some are still calling a bearish rally and others a calming of unwarranted fears, venture investors must still identify signals from the noise. Given the tentatively positive signs, many are forecasting a recalibration of investment levels that could prove milder than what was originally feared. Others state that the extent of overheating in the venture markets was severe enough that we are actually in the early stages of a correction that is still ongoing. Continued mixed forecasts regarding U.S. economic health, especially on a sector-by-sector basis, only complicate matters further for VCs assessing risk levels. Regardless of your current views, we hope the data and analysis in the following pages proves informative and useful.
An ongoing reset
Overview
The term “reset” has been frequently used to describe the VC landscape over the past month. That is likely due to the fact the number of completed U.S. financings has fallen steeply—even if a quarter-end boost occurs, the decline is significant—while capital invested has remained somewhat healthy, potentially reaching a level akin to 3Q 2014 in 1Q 2016. Investors have clearly dialed back the pace of investment, in light of ongoing liquidity concerns, yet of the deals being completed, it’s clear many are justifying hefty sums. Hence the choice of words to describe the shift, as the degree of increase in caution still places it firmly within the bounds of wariness, rather than apprehension.
But which is more warranted? Investors have used the reset in order to shift terms already, particularly at the late stage, as evidenced below by the metric of percentage of ownership acquired. Why they are angling for more downside protection is, in part, due to the average ages of venture-backed startups broken out below by series. It’s no secret that companies have been staying private for longer and longer for a variety of reasons, ranging from the availability of private capital to the disincentive to go public over the past several months. Illiquidity requires a premium, which investors are commanding more emphatically, after multiple years of founder-friendly financings. But as dollars invested persist at a fairly high if less frequent level, it’s clear that even in the current environment of unease, VC firms are willing to pay up in the right cases. Investors are still going long, in other words, albeit with further hedges built into their bets. It’s all about perceived risk for now; hence the counterintuitive increase in proportionate late-stage financing seen below—late-stage fundings do possess less risk than other venture stages, after all. The breakdown of perceived risk at each series will become a more important factor moving through at least the first half of 2016. Venture funds are amply stocked, and consequently will be looking for opportunities to invest, but the correction—or recalibration— will continue to work its way through the financing cycle, likely resulting in more investor-friendly terms, cooling of valuations and round sizes, and a sustained plateau of activity.
A peak or a plateau?
Median valuations
On the surface, overall median valuations seem to indicate that nothing much has changed, across every stage, since the last installment of this report. Only the median of Series B valuations has seemed to decline, and even so, hardly by much. Every other stage of financing is up, with Series D and later rounds seeing a truly mammoth $229 million median valuation in the first two months of 2016.
However, looks can be deceiving, which is why these numbers must be analyzed in the context of declining VC activity. When one considers that the only startups to receive funding in today’s uncertain climate are the ones best primed in VCs’ judgment to survive any potential economic downturn, the level of confidence as expressed by valuations makes sense. It remains to be seen whether these still-lofty numbers represent a peak or a plateau at an elevated level—the latter is more likely. Furthermore, the datasets to the right illustrate the twin feedback effects at both ends of the venture financing cycle that have characterized VC activity over the past half-decade: the entrance of nontraditional venture firms at the late stage, and the broadening of the seed financing market. The former may have helped drive the latter in some part, but of more import has been the intensifying flow of limited partner commitments into seed investors. And, with an abundance of both VC and nontraditional VC dollars chasing returns—as well as public market comparables’ surge and a slew of massive, high-profile successes— exuberance in valuations was bound to occur.
Constrained by perception of risk
Seed valuations and trends
Owing to multiple factors, the seed stage has undergone a marked shift in the past half-decade. More micro VC funds (funds under $50 million in size) have been raised across that time than at any other point in the decade, while angel syndicates have proliferated, broadening the seed stage and helping create the pre-seed environment. Seed investment levels soared to a peak in 2014 by count, while round sizes followed suit a year later. As that surge in median round sizes coincided with a plateau in angel/seed financing activity in number, it’s clear investors were exercising a bit more caution in their investments, yet still, when cutting checks, keeping pace with overall venture inflation.
What’s particularly interesting about that surge in 2015 is how, relative to other financing stages, the seed stage experienced a significant increase in median valuations relatively quickly. After all, the respective increases in round sizes from 2013 to 2015 were $3.4 million to $5.0 million for Series A and $7.1 million to $12.4 million for Series B. The median seed financing, in that same span, more than doubled to $1.1 million. This, more than anything else, illustrates the extent to which the pre-seed and seed financing market has diversified and deepened, with a surge in competitors looking to put money to work. This is attributable not only to aforementioned factors but also increased traditional VC activity at seed, as well as a greater number of sophisticated institutional seed investment firms either forming or ramping up activity. It’s a bit difficult to forecast the extent to which a reset in valuations will affect seed-stage activity, given that same preponderance of institutional seed firms. An exodus of early-stage VCs could occur, if Series A financings deflate somewhat back to historical norms, while seed investors are likely to dial back their investment paces more in 2016, so activity should diminish by a fair amount. How much valuations and round sizes may slide accordingly will by and large be due more to the supply of viable startups than anything else, as available capital remains ample.
