“I would characterise the fundraising market as frenzied,” says Kirsten Morin, co-head of global venture capital at Aberdeen Standard Investments.
Last year was another strong one for venture capital. For the fourth year in a row, North American and European funds raised more than $40 billion. The average size also ticked up, to $149 million, showing this part of the market is following the trend of capital consolidating in fewer funds.
Limited partners that have had long-term venture capital programmes are continuing to allocate steadily, while more recent entrants are building their portfolios, says Brian Rodde, managing director at Makena Capital Management.
Much of the capital flowing into venture is in the hands of late-stage and growth-capital investors.
“The velocity of capital that’s being raised by growth funds is remarkable, and it’s been continuous,” says Morin, adding that fundraising totals since 2016 have been driven by large firms, many of which were historically early-stage investors but have extended into growth.
Rodde sees two drivers of this: the lengthening of the liquidity cycle, which has widened the opportunity to invest in late-stage companies; and large institutional investors needing to put dollars to work, pushing them towards the larger end of the asset class. A recent survey by Hamilton Lane found that while LPs are not planning major increases to their venture capital allocations, 61 percent want additional exposure to technology/growth in their PE portfolios.
This is affecting valuations. While a “new normal” has established at early stage – higher than historical averages but not “nosebleed valuations” – there has been a notable jump at the later stage, says Rodde.
“I think this will have the net consequence of delaying the liquidity of any number of companies even longer because they need to grow into their late-stage valuations before they are going to be acquired or taken public.”
In the US, 2017 was a record year for deal value, with just over $84 billion invested for the first time since the dotcom era, according to the 4Q 2017 PitchBook-NVCA Venture Monitor. But the number of deals closed also dropped as funding round sizes continued to increase; almost 50 percent of activity in 2017 was deals of $50 million or above.
Data compiled by KPMG show dramatic inflation in late-stage rounds, with the average Series D or later round increasing by $10 million to $50 million from 2017 to the first quarter of 2018.
There are both positives and negatives to companies staying longer in private hands, says Theresa Hajer, head of venture capital research at Cambridge Associates. “While there is real value that’s getting created in some companies for sure, there’s the flipside you need to be mindful of in terms of prolonging exits and the risk and return profile of those choices,” she says.
“For LPs it can mean distributions take longer to come, but it’s also about pulling off that growth strategy – how are companies managing that? Some will do it well and there will be some carnage in the process.”
Exits are still sluggish. In the first quarter 188 exits closed at a total of $8.1 billion, compared with 835 at $57.1 billion in 2017 and a high of 1,067 at $80.5 billion in 2014, according to PitchBook. However, multibillion-dollar listings from the likes of Dropbox, Spotify and cloud software provider Pivotal are encouraging.
“Folks have been questioning whether the crop of unicorns would stay private forever and what the end goal was. You’re starting to see evidence that some of these maturing companies are heading for the exits,” says Morin. “There’s been broad market receptivity for technology-related offerings, they’ve traded really strongly, and I think that provides further encouragement for other mature companies to test the public waters.”
Despite potentially concerning signs, Morin and Rodde both remain bullish on venture capital, thanks to what they see as a fundamental change in the way companies are built.
“Part of it stems from capital efficiency and the fact these start-up companies can make a lot of progress with very little capital to launch a product into market,” says Morin.
“By the time they raise institutional venture capital, the traditional Series A, B, C and D, they are much further along in their development and generating real revenues. That is what I see as being a fundamental difference this cycle compared with last cycle. These are real businesses generating real material revenues and I think that helps to substantiate some of the valuations that are being paid to become part of these companies.”
Rodde see the pace of innovation and the way technology is disrupting all industries as fundamental positive drivers behind the asset class.
“At a very basic performance level the asset class continues to perform well. But we know it’s a cyclical and more volatile asset class, so we have eyes wide open about the fact there could be a downturn ahead,” he says.
“As long as we remain steady allocators to the asset class we will capture the long-term trend which I think is very beneficial to venture capital as an asset class. I think the worst thing you can do in this business is try and time the cycle. That’s a fast track to failure.”