David C. Robinson thinks we'll soon see that venture capital is in the process of creative destruction with new market entrants and new models of innovation at the precise moment that the industry itself is contracting.
Last September I wrote about the 2014 Global Venture Capital Confidence Survey from Deloitte and the National Venture Capital Association (NVCA) that showed global investor confidence significantly increased for the third year in a row. Increasing confidence was driven by a combination of favorable capital markets, abundant investment opportunities in innovative companies, and a strong investor climate.
At the time, there was also good news for early-stage companies looking for seed capital. Data recently collected by Shai Goldman on institutional seed investors' funding patterns showed favorable trends that track with the increase in global investing confidence.
More capital into institutional seed funds
First, a number of capital LPs are investing significantly more capital into institutional seed funds - and that number grew by more than 3x in 4 years to about $3B in 2013 reflecting the increased investor confidence globally and in the United States in that same period. Even better than 2014, venture capitalists invested $13.4 billion in 1,020 deals in the first quarter of 2015, according to the MoneyTree™ Report from PricewaterhouseCoopers LLP (PwC) and the National Venture Capital Association (NVCA).
Median institutional seed fund sizes have increased
Second, median institutional seed fund sizes have increased significantly as well, and consolidation and acquisition drive more money into the early-stage markets. I question if these larger funds mean more follow-on capital for second rounds and throughout the lifetime of the business, and if they can sustain seed-stage investments as they grow. Khosla Ventures, which tied for 9th based on seed activity in 2014, is now raising a whopping $400M seed fund in 2015 according to filings.
More institutional fund involvement in seed-stage investing
Institutional funds have typically not participated to any material extent in the development of early-stage investing. In recent years though, their share of total dollars raised has increased significantly to almost 20% of the market, making them a force in seed-stage funding. According to CB Insights data, the number of active seed venture capital investors jumped to a new high – up 23% from the 2013′s total.
The increase in money means that there have been a lot of new institutional seed funds created in the last few years as global investor confidence increased. That has translated directly into both more opportunities for founders raising a seed round, and therefore, more new businesses—as well as to an increase in seed round valuations. As investment returns improve and deal flow remains good, the amount of capital, number of institutional seed investors, and sizes of these rounds completed imply an increase in the number of early-stage start-up companies and therefore greater opportunities to gain market traction with follow-on capital.
Lower first quarter not reflective of overall trends
In Q-1 2015, venture capital (VC) investment declined 10% in terms of dollars and 8% in the number of deals, compared to the fourth quarter 2014 when $14.9 billion was invested in 1,103 deals. The first quarter of 2015 is the fifth consecutive quarter of more than $10 billion of venture capital invested in a single quarter.
“Although down slightly from the end of last year, the venture ecosystem deployed a healthy amount of financial capital to the startup ecosystem at the start of 2015, surpassing the $10 billion mark for the fifth consecutive quarter. According to the NVCA, this is setting the stage for what is expected to be another busy year for startup investing,” said Bobby Franklin, President and CEO of NVCA. “Last quarter, it was great to see healthy first-time funding levels and that the majority of deals were seed and early stage. Balancing the investment in megadeals, venture capital investors remain focused on building the next generation of companies.”
“Historically, VC investing in the first quarter of the year is typically slower than the rest of the year. So, the drop in dollars invested compared to Q4 is not necessarily indicative of what’s to come in 2015. In fact, the $13.4 billion invested in Q1 of this year is the highest first quarter total since 2000 and is a 26 percent increase in dollars compared to Q1 of last year,” remarked Tom Ciccolella, US Venture Capital Leader at PwC. “We saw twelve deals over $100 million including two $1 billion investments in Q1, continuing the mega-deal trend. One of the billion dollar investments was in the Later Stage of development that contributed, in part, to dollars invested in Later Stage companies doubling in Q1 compared to the prior quarter.”
A sea change in early-stage funding
This environment is a sea change from the past when raising a seed-stage round meant going to “friends, family, and fools”. And, while there were a few notable Angels, well-organized Angel syndicates and firms like FirstRound Capital, TrueVentures, Floodgate, and SoftTech were all brand new or just forming. There were no start-up ecosystems like Y Combinator, 500 Startups, TechStars, Amplify, Mucker and countless others.
I would argue that these relatively new changes to the industry will be a lasting change. I think we'll soon see that venture capital is in the process of creative destruction with new market entrants and new models of innovation at the precise moment that our industry itself is contracting.
When the dust settles, we may have fewer firms, but with each type of fund more focused on traditional stage segments that cater to the core competencies and historical successes of the firm's partners. In my opinion, the current trend of funding anything from the first dollar to funding $400 million+ “Unicorns” at billion+ dollar-valuations is unlikely to last, despite the heady investment patterns of 2014 and 2015 year-to-date.
The move toward more support of seed-stage investing has gained momentum in the last few years, and the advent, support and even some success of the incubator and accelerator systems seem to be here to stay. If the last two years are any guide, seed-stage investing in the <$1M range is quickly becoming a part of many VC portfolios' strategies.
The nuviun blog is intended to contribute to discussion and stimulate debate on important issues in global digital health. The views are solely those of the author.