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Fund Partners Spinning Off Smaller Funds
VC Investment and Exits Slow, But the VC Ecosystem Looks Strong
VC investment and exits in the first half of 2017 continued to “self-correct,” as they did in the second half of 2016. This “normalization” has, per usual, made early-stage venture capital investment the most challenging. https://venturebeat.com/2017/04/04/venture-capital-returned-to-normalcy-in-q1-2017.
However, an eight-quarter decline in seed and angel investing may be explained as much by a greater number of startups with less capital-intensive and more bootstrapped business models than a decline in angel interest or quality companies. Like many commentators, we see declining valuations, an uptick in venture-backed company IPOs, the big data revolution and a huge supply of newly raised capital as good signs for the VC ecosystem. Venture Monitor 2Q 2017, Pitchbook Data, Inc. and National Venture Capital Association (“Pitchbook/NVCA 2Q Monitor”) .
Let’s start with the less-good news — early-stage VC investment and exits — and then take stock in strong VC fundraising. The trend toward larger investments in fewer companies continues, making Series A and B rounds tough to close. Late-stage (C- and D-round) investments have increased as companies remain private longer, but this can reduce investor returns. Corporate venture investment continues to decline as corporates appear to prefer more mature companies and fewer, larger stakes. Pitchbook/NVCA 2Q Monitor.
The majority of VC-backed companies will exit via a sale versus an IPO. Even though the IPO window seems to have opened, the performance of completed IPOs has not been stellar (consider Snapchat and Blue Apron Holdings). Wall Street Journal, July 12, 2017, B15, “Snapchat’s Parent is Fading Out.” VC exits in value and deal number continue to decline, although the decline has been offset in part by an increase in private equity buyouts in the technology sector (versus strategic acquisitions). Perhaps the most negative statistic is a rise in the ratio of VC investments to VC-backed company exits. Longer capital-raising and holding periods, again, usually reduce investor returns and increase risk.
VC fundraising may not surpass 2016 in 2017 but is still extremely healthy, with 87 percent of closed VC funds hitting their targets in the first half of 2017. First-time funds are on the increase, with those boasting operating partners with vertical expertise and focused on “next big thing” sectors getting the most traction. Pitchbook/NVCA 2Q Monitor. Twenty-two first-time funds raised $2.2 billion in commitments in 2016, the largest by first-time managers since 2008. http://nvca.org/pressreleases/2017-nvca-yearbook-highlights-busy-year-venture-industry.
Despite the decline or pause in angel, seed and Series A investment and VC-backed exits, which are relative when compared to an overly frothy market in 2015, we believe the VC ecosystem remains healthy and that good companies with shorter runways to exit will continue to benefit from a large amount of available capital, unprecedented technology advancements and consolidation. Limited partners have not lost their appetite for technology-oriented venture capital and private equity funds. A recent poll by Upfront Ventures suggests that VCs are much more optimistic than they were a year ago. In part, this is due to unbelievable advances in software and technology, as VCs see artificial intelligence and machine learning as the most promising area of technology in which to invest. As long as there are innovation and capital, the two will somehow find a way to meet. https://bothsidesofthetable.com/why-2017-should-be-a-great-year-to-raise-venture-capital-787773e8b707.
Fund Partners Spinning Off Smaller Funds
Like lawyers, VC fund partners tend to move around. But there has clearly been a recent increase in departures of established fund partners who are raising first-time funds. Fortune recently provided the following list of first-time funds started by partners who spun off from their former funds. http://fortune.com/2017/05/18/venture-capital-spin-off-funds
|New First-Time Fund
Radian Capital Bain
Kleiner Perkins/Maverick Capital
|Earlybird Venture Capital
Foundation Capital; Founder Collective
Most of these new funds are small, ranging from $15 million to $150 million. This should be a good thing for startups seeking seed and early-stage investment.
Private Equity Continuing Migration to Tech
For some time, private equity funds have moved down-market to do growth equity deals or buyouts of VC-backed technology companies. The opportunity for outsized returns is hard to resist when compared to investments in manufacturing, retail, consumer, energy, real estate and other traditional PE sectors. As many technology companies grow and remain private longer, more of them have a private equity buyout as an alternative to a strategic sale or IPO. Even as VC-backed exit activity has declined, buyouts (both platform and secondaries) have increased as a portion of all exits (including buyouts, acquisitions and IPOs).
In the first half of 2017, technology companies (specifically, IT and B2B) secured a greater share of private equity investments, continuing to take a larger share from previously hot sectors, such as healthcare and consumer products. The Internet and SAAS are yesterday’s news. Big data and artificial intelligence are converging with every industry sector. Large corporations and, now, private equity, get that. Technology is “creeping into every other sector — effectively, every company has to reimagine themselves as a digital company today.” With software and other technologies being the darlings of VC, initial and secondary buyouts by private equity funds offer an exit alternative to corporate acquisitions and IPOs, which ebb and flow. Pitchbook Data, Inc., US PE Breakdown, 2017 Q2.
Seattle Becomes a Legitimate Second-Tier VC Hub
Seattle, or should we way, the state of Washington, is no fluke. Washington ranked fourth behind California, New York and Massachusetts in the number of resident companies receiving VC dollars in the second quarter 2017. The Seattle-Tacoma-Bellevue MSA was sixth in second-quarter 2017 VC deal count, beating out hubs like San Diego and Austin. Pitchbook/NVCA 2Q Monitor. It doesn’t hurt to have Amazon and Microsoft in town. They throw off a lot of entrepreneurial talent. While Seattle and Washington state VC activity pales by comparison to first-tier hubs San Francisco/San Jose, New York and Boston, Seattle beat second-tier hubs like Chicago, Austin, Atlanta and Washington, D.C., in VC funds raised since 2006, the number of VC rounds closed since 2010 and total exit value since 2010. Software, biotech and healthcare are Seattle’s sweet spots, thanks to Microsoft, Amazon and a network of medical research centers and hospitals serving the northwest. Venture Ecosystem Factbook: Seattle, Pitchbook Data, Inc.
Software Is Growing Up: Grabs 42% of Venture Capital in First Half 2017
Software companies continue to dominate venture capital investment, taking a bigger share than old VC darlings like biotech, healthcare and media. Several reports suggest software has garnered between 36 percent and 42 percent of U.S. VC funding, with the next-best sector, biotech, way behind, at 17 percent. World Economic Forum, These are the industries attracting the most venture capital; https://www.weforum.org; Pitchbook/NVCA 2Q Monitor.
As mentioned earlier, software serves almost all other industry verticals. The rapid evolution of cloud and software-as-a-service solutions into “smart” machines providing data analytics and artificial intelligence is driving innovation in healthcare, insurance, financial services, transportation, and seemingly every other sector of our economy. No longer is software just helping businesses conduct routine operating tasks — it increasingly is providing business intelligence and supporting smart machines through data analytics and integration across all disciplines of the business, from sales and marketing, to product and service development, delivery and distribution.
With overall exit activity declining, software companies represented 54 percent of exits so far this year, thanks in part to increasing private equity interest in software. During the second quarter of 2017, software companies represented four of the top 10 largest venture deals and two of the five largest IPOs. Pitchbook/NVCA 2Q Monitor. Today, the software company label seems inadequate, as software companies are no longer about shrink wrap or CDs, but rather about providing technology platforms, cloud-based services, and now, deep learning to businesses in every industry.
CB Insights did a study indicating that startups who received early VC backing had some or all of the following buzz words in their business plans or descriptions: “platform,” “data,” “users,” “mobile,” “software,” “app” and “network.” The word whose appearance has grown by over 1000 percent is “artificial intelligence.”
“Advertising and e-commerce are out, AI and insurance tech are in. These are the industries that have the eye of elite venture investors.” https://www.cbinsights.com/blog/smart-money-startup-funding-trends.
Sector labels can be misleading and even skew statistics. But it’s clear that, by whatever name, “deep tech,” “the internet of things,” “big data” and “AI” are contributing to innovation and driving investments in other sectors, from financial institutions, to agriculture and food, to insurance and healthcare. Not to mention energy and manufacturing. Venture Pulse: Q1 ’17 Global Analysis of Venture Funding, https://home.kpmg.com/xx/en/home/insights/2017/04/.
Top 10 Mistakes Made by Entrepreneurs
This list is from Working Knowledge, Harvard Business School, by Constance Bagley:
#10 Failing to incorporate early enough
#9 Issuing founder shares without vesting
#8 Hiring a lawyer not experienced in dealing with entrepreneurs and investors
#7 Failing to make a timely 83(b) election with the IRS
#6 Negotiating venture capital financing based solely on valuation
#5 Waiting to consider international intellectual property protection
#4 Disclosing inventions without a nondisclosure agreement or before a patent application is filed
#3 Starting a business while employed by a potential competitor, or hiring employees without first checking their agreements with their current employer and their knowledge of trade secrets
#2 Promising more in the business plan than can be delivered and failing to comply with state and federal securities laws
#1 Thinking any legal problems can be solved later