Startup Funding at 15 Year High While Capital Efficiency Drops Sharply

by the Curmudgeon


The Money Tree Report:


Venture capitalists and other institutional investors put $17.5 billion into startup companies during the 2nd quarter- the highest level in nearly 15 years, according to the most recent Money Tree report from Pricewaterhouse Coopers (PwC) and the National Venture Capital Association.


As expected, the majority of the funding went into software and media/entertainment companies.  The software industry raked in more VC funding during the 2nd quarter than in any time in the report's 20-year history. Software investments have led for 23 quarters straight, according to Tom Ciccolella, U.S. venture capital leader at PwC.


Some data points from the Money Tree report:



Here's a chart showing Silicon Valley startup investments:


Dow Jones VentureSource Survey:


An even higher amount of VC spending in the 2nd quarter was reported by Dow Jones VentureSource (password protected website). The $19.19 billion invested from April through June 2015 was a 24% increase over a year earlier and nearly matched the fourth quarter of 2000, when $19.72 billion was invested.


Total investment in the first half of this year was $35.92 billion, more than the $35.71 billion put into U.S. venture-backed companies in all of 2013. Last year’s total was $57.02 billion.


Investors in the second quarter pumped $11.62 billion into 358 late-stage financing rounds, an amount that was 15% higher than in the second quarter of 2014.   The largest investment was a $1.5 billion financing for home-rental service Airbnb, which The Wall Street Journal said valued the company at $25.5 billion and included public-market investors such as mutual-fund firm Fidelity Investments.


The hot later-stage market has put pressure on deal valuations at all financing levels, venture investors say.  For some VC firms, the bigger rounds mean fewer investments -- and bigger risks. When investing partner Tomasz Tunguz joined Redpoint Ventures in 2008, the average investment for the firm was about $3 million to $5 million, he said. Now, it's $10 million.


Capital Efficiency Declines Across the Board:


Startups are raising more money, but exiting for less than in previous years, says CB Insights in this blog post.  Between 2012 and 2014, the capital efficiency ratio for $1B+ exits has been cut in half, according to the VC/startup investment tracking firm.


When analyzing yearly data, CB Insights found that large exits are actually becoming less capital efficient over time.



For the full period 2009 to 2015 year-to-date, unicorns stand out as having the most efficient exits, with a median capital efficiency ratio of 15.3x, more than twice as high as the ratio for exits in the $100M-$500M range, which had a median capital efficiency of 6.3x.


Comment & Analysis:


The involvement of hedge funds, private equity groups, sovereign wealth funds, and even mutual funds continues to drive up the price tag on funding rounds. It's not just VCs in the driver’s seat anymore!


Despite the dollar amount of funding going up, the number of deals has remained fairly steady – somewhere between 300 and 400 each quarter in Silicon Valley for the past few years and averaging 1,093 a quarter nationally, according to the latest Money Tree report. The result is that a handful of mature private companies are receiving a disproportionate chunk of the money invested each quarter.  None of them makes any tangible products or real things!


Other Voices:


"The opportunities to disrupt and innovate only happen every so often, so you need to be there in force," said Jeffrey Grabow, U.S. venture capital expert at consulting firm EY. "You can't just wade in."


"With software companies continuing to disrupt entrenched industries and in some cases creating new industries all together, venture investment into the sector increased 30 percent from the first quarter to $7.3 billion," Bobby Franklin, CEO of the National Venture Capital Association, said in a statement.  "As valuations increase and more and more companies choose to stay private longer, we are likely to see software's share of total venture investment continue to rise."


"Software companies are easier to get up and running and easier to scale in comparison to other industries that are a bit more capital intensive," Tom Ciccolella said. "Companies are generating significant revenue and changing and disrupting entire industries ... they are changing the way people interact with different industries."


Scott Sandell, a managing general partner at New Enterprise Associates, one of the world’s largest venture firms, said that valuations of midstage companies and the amount of capital available to them continue to rise “in ways that make us really nervous.”  He added that his firm sees lots of companies where “we like all the things we see, but the valuation is just too high.”


Note: The median pre-money valuation of later-stage rounds in the first half of this year was $310 million compared with $213.3 million for all last year.


Mr. Sandell said one thing that worries him is the speed with which deals are getting done. Where two months was once the norm, especially for later-stage deals, “what we’re seeing now is sometimes the rounds come together in weeks and sometimes inside of a week,” he said.  His concern is that investors, including those more accustomed to dealing with initial public offerings, aren’t getting enough information about the companies they are backing.




There are several important take-aways from these three reports on startup investments:


  1. It's a software, media & entertainment world- almost ZERO is going into IT infrastructure or electronics/ semiconductors.
  2. The capital efficiency ratio (which determines ROI) has declined by >50% for unicorns and a bit less for other startups.  Yet none of the VCs ever mention that.
  3. The median valuation of later stage investment rounds has increased by almost 50% in the last year to $310 M.
  4. VC's are trying to outbid one another to put money into “hot startups” so as not to miss the next big thing.  That might be looking through the rear view mirror!
  5. Deals are getting done a lot faster, with investors not getting enough information on the companies they are pouring money into.  Is that indicative of a mania?


As always, we present the evidence and let the reader be the judge.


Till next time..............


Previous Curmudgeon posts on this topic:


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Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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