We analyzed the terms of 180 venture financings closed in the third quarter of 2014 by companies headquartered in
Overview of Fenwick & West Results
Valuation results continued strong in 3Q14, but declined from 2Q14, which was the strongest quarter in the 12-year
history of our survey.
Overview of Other Industry Data
Consistent with our results, third party data on the overall U.S. venture industry showed that the third quarter of 2014 was
a strong quarter, but not as strong as the second quarter of 2014.
1 As reported April 2014
2 Dow Jones VentureSource (“VentureSource”)
3 The PWC/NVCA MoneyTree™ Report based on data from Thomson Reuters (“MoneyTree”)
4 CB Insights (“CBI”)
Although investment levels in 2014 have been strong, they are substantially lower than dot-com levels, even before adjustment for inflation over the past 15 years.
Aggregate investment for the first three quarters of 2014 was $37 billion, which is higher than the $35 billion invested in all of 2013, according to VentureSource. However, deal volume through the first three quarters of 2014 is running slightly behind the first three quarters of 2013, 2780 to 2803.
There has been a good deal of talk lately that venture backed companies are significantly increasing their burn rate, as investment becomes easier to attain, and concerns as to what will happen if available investment declines. Pitchbook has put together some data that supports the proposition that burn rates are noticeably increasing, at least as to late stage U.S. software companies.
But the question remains as to whether these increased expenditures are imprudent/ unsustainable, or a necessary risk in an environment that puts a premium on being first to market, building share rapidly, going global quickly and hiring the best talent.
Distribution of Venture Returns
It is well known that venture investing is a very risky business, with the key to success often being the one investment that provides a huge return to offset the numerous money losing or small return investments in a fund. Sometimes a chart helps illustrate a point, so to that end we provide the below chart from Correlation Ventures, based on their analysis of the returns of venture backed companies that exited in the 2004-2013 time frame.
However, there was only one U.S. based venture backed tech company IPO in 3Q14, as over 75% of the IPOs were life science companies, and five of the IPOs were non-U.S. based. One possible reason is that the Alibaba IPO froze the tech IPO market in 3Q14, but the dominance of life science IPOs is not limited to this quarter, as though the first three quarters of 2014, 60 of the 85 IPOs (71%) were in the life science industry.
The post IPO market has been choppy for recent venture backed IPOs. Of the venture backed companies that went public in the first three quarters of 2014, 47% were below their offering price as of the end of the third quarter, according to Marketwatch. And the Thomson Reuters Post-Venture Capital Index, which measures the change in stock price of venture backed companies that went public over the past ten years, is down 17% in 2014 through September 30, 2014, which compares unfavorably to the overall Nasdaq which was up 8% in the same time frame.
The $20 billion of proceeds was the highest quarterly amount since 3Q00, and with the large WhatsApp acquisition having already closed in the fourth quarter, 2014 will have the highest annual M&A proceeds since 2000 by a significant margin.
Similarly, Thomson/NVCA reported a 22% increase in acquisition deals in 3Q14, with 119 deals in 3Q14 compared to 97 in 2Q14 (as reported in July 20141), with 76% of the deals being in the IT industry.
Concentration of Buyers
An analysis of venture backed tech companies acquired for $500 million or more in the 2008-June 2014 time frame shows that acquisitions by just three companies (Facebook, Cisco and Google) accounted for 44% of the total $78 billion paid in such acquisitions, according to CBI.
Venture Backed Buyers on the Rise
One interesting trend is that M&A involving both venture-backed buyers and sellers is at the highest level since at least 2004, according to VentureWire. Through the first half of 2014, venture backed companies acquired 50 other venture backed companies, accounting for 21% of all venture backed companies that were acquired. The likely reasons for this trend include a very selective IPO market encouraging companies to have significant scale before going public, and a good number of venture backed companies with high value stock and substantial cash resources to make acquisitions.
Some concerning news for tech bankers though is that not only were tech IPOs low this quarter, but tech acquirers appear to be reducing their use of investment bankers, with 69% of tech acquisitions worth more than $100 million not using bankers in 2014, compared to only 27% ten years ago, according to the New York Times based on data from Dealogic.
Although 3Q14 was less strong than 2Q14, 2014 overall has been a strong year for fundraising, with the $23.8 billion raised through the third quarter already surpassing the $17.6 billion raised in all of 2013, and on track to possibly be the best year since 2001. And the number of funds raising money has also been healthy in 2014, as smaller funds are having increasing success raising money.
While the increase in fundraising is generally welcome, it remains to be seen whether the upswing reflects an increased long term commitment by LPs to the venture sector, or a short term reaction to recent increased distributions and returns in the industry.
Corporate venture groups provided the largest percentage of total investment in the biotechnology and semiconductor sectors (14% each), followed by telecom (13.3%), industrial/energy (12.8%) and medical devices (10.8%).
The growth of corporate venture investment in the life science sector is especially noticeable, with 2013 the first year since at least 1995 where CVCs provided over 10% of total venture dollars into the life science industry (10.1%), and 2014 is on track to substantially surpass that, as CVCs have provided over 13% of total venture dollars invested in life science through 1H14.
The involvement of hedge/mutual funds is an important source of funding for companies that cannot or do not want to go public, but the high valuations and perhaps different negotiating strategies of these funds has caused friction at times with traditional VCs, according to two articles in the Wall Street Journal.
Public Markets More Discerning?
Hedge/mutual fund investments in venture backed companies has contributed to 24 venture backed companies receiving $1 billion or higher valuations in private investments in 1H14, while only six venture backed companies went public with a valuation of $1 billion or more in 1H14, the largest difference since at least 1992, according to the Wall Street Journal.
This might seem surprising, as arguably secondary funds should have more opportunities in down markets, when investors and employees need liquidity and other liquidity options are less available. But with many of the more successful companies voluntarily delaying liquidity events, yet still wanting to provide some liquidity to investors, and especially employees (with liquidity opportunities being a potential selling point to employees in a very competitive labor market) there are reasons for increased secondary opportunities.
And if you are a believer that the market is over heated, now might be a good time to assemble some dry powder in secondary funds and wait for future opportunities. But with hedge funds and mutual funds driving up late stage valuations, caution is warranted.
One recent development reported by VentureWire is Techstars’ decision to accept more mature startups into its accelerator program and to offer an “equity back guarantee” if companies aren’t satisfied with their experience at Techstars. There has been some discussion that accelerators could start investing more in their most promising companies, effectively competing with venture capitalists, but this action by Techstars seems to point them in the direction of expanding their focus on mentoring and networking, and not on increased investment.
Another development worth watching is the syndicate program of Angelist. The syndicates, dubbed “Pop-Up VCs”, consist of a leader who curates/selects companies listed on Angelist in which to invest, and passive investors who follow such leader (based on his/her track record/experience), co-invest on a deal by deal basis, and pay the leader a carry on deal profits. Currently, the largest of these syndicators, according to Strictly VC, is Gil Penchina, who has attracted 1300 investors to back deals he selects, and is trying to “build a Fidelity” with syndicates that specialize in different industry sectors.
A recent academic study on crowdfunding cited in the New York Times argues for the value of the “wisdom of crowds.” Although the study was focused on the theater industry, not the tech industry, it found that crowd funded theater projects were just as likely to be successful as projects picked by experts. Although the “wisdom of crowds” may be more valuable in areas where crowds have more knowledge (e.g., consumer focused products and projects), those areas are a significant part of the venture ecosystem and could provide a wealth of information for those looking for information on consumer behavior.
A Wall Street Journal article discussed who is going to take the big risks. With federal government R&D funding declining as a percentage of GDP, large corporations doing less fundamental research (consider the reduced footprint of Bell Labs, Xerox Parc and Sarnoff Labs – although Google is an exception) and seeming to view acquisitions as a large part of their R&D strategy, and venture capital funds generally not structured for investment in long term fundamental research, we may be becoming increasingly reliant on ultra-wealthy individuals to fund the most speculative research in areas like space exploration, genome sequencing, clean energy development and longevity research.
Or will the average person, through crowdfunding, play a significant role?
The Deloitte/NVCA 2014 Global Venture Capital Confidence Survey found that global venture capitalists had more confidence in investing in the U.S. than any other country, with Israel second and Canada third. Despite that vote of confidence in the U.S. environment, venture capitalists in the U.S. had less confidence in U.S. government policies than venture capitalists in any other country felt about their own government. Notable concerns were patent reform, immigration policy and crowdfunding regulation.
Price Change — The direction of price changes for companies receiving financing in a quarter, compared to their prior round of financing.
The percentage of down rounds by series were as follows:
The Fenwick & West Venture Capital Barometer™ (magnitude of price change) — Set forth below is the average percentage change between the price per share at which companies raised funds in a quarter, compared to the price per share at which such companies raised funds in their prior round of financing. In calculating the average, all rounds (up, down and flat) are included, and results are not weighted for the amount raised in a financing.
The Barometer results by series are as follows:
Results by Industry for Price Changes and Fenwick & West Venture Capital Barometer™ — The table below sets forth the direction of price changes and Barometer results for companies receiving financing in 3Q14, compared to their previous round, by industry group. Companies receiving Series A financings are excluded as they have no previous rounds to compare.
Down Round Results by Industry — The table below sets forth the percentage of “down rounds,” by industry groups, for each of the past eight quarters.
Barometer Results by Industry — The table below sets forth Barometer results by industry group for each of the last eight quarters.
A graphical representation of the above is below.
Median Percentage Price Change — Set forth below is the median percentage change between the price per share at which companies raised funds in a quarter, compared to the price per share at which such companies raised funds in their prior round of financing. In calculating the median, all rounds (up, down and flat) are included, and results are not weighted for the amount raised in the financing. Please note that this is different than the Barometer, which is based on average percentage price change.
Median Percentage Price Change Results by Industry — The table below sets forth the median percentage price change results by industry group for each of the last eight quarters. Please note that this is different than the Barometer, which is based on average percentage price change.
A graphical representation of the above is below.
Financing Round — This quarter’s financings broke down by series according to the chart below.
Fenwick & West Data on Legal Terms
Liquidation Preference— Senior liquidation preferences were used in the following percentages of financings.
The percentage of senior liquidation preference by series was as follows:
Multiple Liquidation Preferences — The percentage of senior liquidation preferences that were multiple liquidation preferences were as follows:
Of the senior liquidation preferences that were a multiple preference, the ranges of the multiples broke down as follows:
Participation in Liquidation — The percentages of financings that provided for participation were as follows:
Of the financings that had participation, the percentages that were not capped were as follows:
Cumulative Dividends – Cumulative dividends were provided for in the following percentages of financings:
Antidilution Provisions –The uses of antidilution provisions in the financings were as follows:
Pay-to-Play Provisions – The percentages of financings having pay-to-play provisions were as follows:
Note that anecdotal evidence indicates that companies are increasingly using contractual “pull up” provisions instead of charter based “pay to play” provisions. These two types of provisions have similar economic effect but are implemented differently. The above information includes some, but likely not all, pull up provisions, and accordingly may understate the use of these provisions.
Redemption– The percentages of financings providing for mandatory redemption or redemption at the option of the investor were as follows:
Corporate Reorganizations – The percentages of post-Series A financings involving a corporate reorganization (i.e. reverse splits or conversion of shares into another series or classes of shares) were as follows: