Navigating today’s VC landscape
A mid-year market review
At the beginning of 2018, Fuel Venture Capital provided its Limited Partners with an in-depth overview of the venture capital/private equity industry, where important developments observed by analysts were parsed and contextualized. As we move closer to the final quarter of 2018, we felt it important to revisit some of these trends and provide a timely update on key themes. What follows is an adaption of this internal memo.
Increasingly, we have begun dedicating our internal resources toward four specific activity areas: the increase in private market valuations; the growth of non-traditional investor interest in venture capital; a demand for the emerging technology sector from retail and institutional investors; and, a landscape shifting away from historic venture and startup geo-centers, such as Silicon Valley.
Valuations — the public/private tug of war
What do we see? Where is this market going? To start, we can share facts, which indicate a trend.
Private markets currently are characterized by high valuations, even higher deal value, increasing deal sizes, increased capital availability and as a result, a widening gap between angel/seed and Series A rounds. In the first half of 2018, a total of $57.5 billion were invested in nearly 4,000 U.S. VC-backed companies. Historically, only four out of the past ten years have had such robust early-stage VC activity. If this momentum continues into the second half of 2018 as we expect, 2018 will have the highest deal value over a ten year period.
Intensifying the strength of the venture capital industry is the upward shift in round sizes and a reduction of round activity, pointing to a continuing trend of capital that is concentrated into fewer and significantly larger rounds.
According to the 2018 Pitchbook Venture Monitor, early-stage deal size rose to a decade high of $18 million, while the median deal size of a Series A round has increased from $8.7 million in 2017 to $11.3 million in the first half of 2018. Similarly, the median deal size of a Series B round has increased from $24.3 million in 2017 to $29.3 million in the first half of 2018. This further illustrates the widening gap between Angel/Seed and Series A stages. Between 2017 and through June of 2018, the gap widened to 36%.
As one would expect, the excessive “dry powder” present in the venture capital landscape has contributed to higher valuations and longer exit times.
Although the average time to exit has declined from 6.3 years in 2017 to 6.1 years in 2018, a slight hiccup, time to exit activity has increased by more than one year in the past decade. Buoyed by excessive deployable capital reserves in the private market, we expect that the longer trend of increasing time to exit will continue as companies seek liquidity in the private, rather than the public market. It is for this reason that Rokker Fuel maintains exclusive partnerships with source generators such as Rokk3r Labs and the Holt Fintech Accelerator, among other select incubators, accelerators and company builders. Their focus is on providing founders and entrepreneurs access to education, idea validation, team creation, expert advice and executive development. Where we provide the catalyst capital for early-stage and early-round growth, they assure that the success ratios are greater, validations are higher, and the timeline to exit is significantly reduced — an almost unfair advantage for any investor as these companies are selected for inclusion in venture capital portfolios, such as that of Fuel Venture Capital.
Nontraditional investors and the creative economy
Nontraditional investors, such as family offices, sovereign wealth funds, and mutual funds, ramped up participation in alternative investments, specifically venture capital. Their long-term value seeking directive fits well in the early-stage ecosystem.
The emergence of a new pool of investors within the venture capital landscape has caused significant changes in the venture capital landscape by shortening the fundraising timeline, offering increased capital availability and accessibility, and extending companies’ ability to stay private. If current activity persists, more than 1,500 deals will be completed with nontraditional investor participation in 2018.
Nontraditional investors are seeking alternative paths to invest in cutting-edge, innovative companies in earlier stages — where the impact of their capital will grow exponentially and scale over longer horizons. Series D deal flow with participation from nontraditional investors rose 11.1% through June 2018, with by Series B rising 6.8%. Overall, Series B is seeing the fastest increase in deal flow, with a 35% jump over a two-year period.
We expect nontraditional investors, especially family offices and select Registered Investment Advisors, will continue to prove an important source of investment assets for the venture capital ecosystem.
According to the 2017 Global Family Office Report, 13.2% of the typical family office portfolio is dedicated to direct VC/PE or co-investing, and 70% of family offices engage in direct investing.
Family offices are not new to venture, having engaged in 1,321 venture capital financing rounds in the decade prior to 2017. The participation of multi-family offices (MFOs) in alternative investments has surged over the past two decades with an increased accretion of wealth, a rethinking of traditional asset allocation, and savvy, sophisticated investors with deep networks. Family offices, with only around 10,000 that operate worldwide, may seem like a relatively small entrant into the Venture Capital landscape; however, these offices manage in excess of $4 trillion in assets.
Firms like Fuel Venture Capital have deliberately designed their infrastructure around the growth potential and investment impact that single and multi-family offices are having on the venture space, bringing to bear decades of experience and education in wealth management, private banking, alternative investments and consulting. It is critical to recognize that today’s sophisticated investor is seeking a well-diversified portfolio that is properly aligned across as many as a dozen distinct asset classes, and they require investments that are unique and impactful, both in their exclusivity and non-correlated performance.
Breakdown by Sector: Tech, and More Tech
Where does the flow actually go? In a market awash with capital, the top sectors receiving investor funds are software, biotech, health-tech and life sciences. Through June of this year, $23.69B flowed into software followed by $9.67B in pharma and biotechnology. Software continues to dominate deal count and deal value, with greater than 40% of invested capital flooding into the software sector.
Technology, consumer and healthcare saw the strongest IPO performance. Healthcare dominated in deal count with 70 IPOs, but the technology sector had higher total deal value. With 51 deals netting $23B in 2018, technology remains significant. For example, in the second quarter of 2018, two thirds of the largest fintech rounds were raised by companies that leverage blockchain.
Not surprisingly, the Fuel Venture Capital investment thesis itself centers on concepts of exponentiality and the convergence of transformational, disruptive technologies. We believe companies that leverage algorithms, artificial intelligence, blockchain and machine learning to drive actionable decisions in particular the have potential for higher future growth and the ability to disrupt traditional markets. However, we stress that with the increase in activity also comes the need for strict investment discipline, a focus on company development, an eye toward Key Performance Indicators, and the positioning of a fund and its partners for opportunistic, yet sound, investment and co-investment.
Times, They Are A-Changin’
While there are no significant changes to the geography of the venture capital investment landscape, non-traditional hubs such as Portland, Oregon, Wilmington, Delaware and Miami, Florida are beginning to amass burgeoning startup ecosystems. Increased connectivity and the democratization of information through new technologies have allowed post-industrial cities to rebrand themselves as America’s new tech hubs.
In its 2017 Startup Activity Index, The Kauffman Foundation ranked the Miami-Fort Lauderdale MSA as having the highest startup activity in the U.S., based on the rate of new entrepreneurs, opportunity share of new entrepreneurs and startup density. A less concentrated, more representative venture capital landscape would help distribute job growth, provide access to opportunity and would accentuate state and local economic development. For entrepreneurs, moving to these evolving tech hubs provides lower overhead, access to a new talent pool, and more chances for favorable local governmental support.
A recent Economist article, “The New Geography of Innovation — Why Startups Are Leaving Silicon Valley,” highlighted the growing trend of Silicon Valley investors pouring capital in startups outside of the Bay Area. We expect this trend will continue, with funds beginning to expand into new hubs, like Miami, for technology, entrepreneurship and innovation. And importantly, income tax reforms on the horizon that may impact venture capital investment managers could provide a catalyst for investors seeking new markets to leave Silicon Valley to source entrepreneurs and inject capital elsewhere.
We are witnessing a period of explosive growth in the venture capital market, one that is incredibly exciting for founders and entrepreneurs, and potentially quite advantageous to investors and managers.
With higher startup valuations, an increase in deal sizes and values, and an increase in available capital, the pace has quickened. And there is a window for tremendous opportunity. But where there is opportunity, you will find risk.
The widening gap between angel rounds, seed rounds and subsequent Series A deals calls for caution and careful evaluation as investors and funds deploy capital. Evidence of proper and systematic due diligence, both at the company and fund level, is essential. Choose your partner wisely. Fuel Venture Capital itself maintains exclusive partnerships with deal-flow sources that have a plan, process and discipline around the development of emerging companies, and we are able to validate, verify and rely upon the methods used to provide portfolio opportunities to our partners.
Never have we seen a greater need for partnership. More nontraditional investors than ever are seeking alternative paths to investing in cutting edge, innovative companies at earlier stages, where the impact of their capital will grow exponentially and scale over longer time horizons.
Firms, family office groups and sophisticated individuals are rethinking traditional asset allocation and require investments that are unique and impactful, both in their exclusivity and non-correlated performance. They demand unique opportunities that originate from non-traditional hubs, with concepts that center on notions of exponentiality and the convergence of transformational, disruptive technologies. Moreover, they represent an exodus of investors from the traditional and inefficient startup ecosystems in California, toward the rapidly advancing technology hubs of the Southeast, Northwest and Mid-Atlantic.
These are the technology entrepreneurs and fund managers that are sourcing and curating companies with greater future growth potential and the ability to disrupt traditional markets — exactly what the savvy investor requires.
This post was authored by Fuel Venture Capital Analyst Olivia Gaudree. Olivia provides operational and analytical support to Fuel General Partners, Limited Partners, and portfolio companies, in addition to guiding prospective founders through stages of the due diligence process. To reach Olivia, email her at olivia@fuelventurecapital.com. Follow Fuel Venture Capital on social media, via Instagram, Twitter and LinkedIn.
