Outlook Remains Upbeat
Venture capital (VC) outlook remains upbeat despite mixed 1H 2017 exit trends. In our conversations with private tech investors, a common theme emerged: The supply of money is at an all-time high. The record-high fundraising activity of the past 18 months has been driving the growing amount of dry powder. The upshot is that valuation discipline has returned to the Valley. The investment thesis has shifted from “growth at all costs” to “growth with fundamentals.”
From an exit standpoint, the upward trend in IPO activity is encouraging despite an increase in the number of down-round IPOs. Investors have breathed a sigh of relief that the predictions of “countless dead unicorns” haven’t come true. Investors also appear surprised that large tech companies have been relatively quiet on the mergers and acquisitions (M&A) front, despite record high share prices. Looking ahead, investors believe that both M&A activity and IPOs will rise in 2018. This expected pickup in exit activity, while a somewhat self-serving prophecy, stems mostly from fact that entrepreneurs and companies have adopted a “wait and see” policy around the volatility of the Trump regulatory regime.
SoftBank’s shadow looms large over Silicon Valley. Announced in late 2016, SoftBank’s Vision Fund closed its first round of $93 billion in May. It could total up to $100 billion by the end of 2017. While SoftBank has committed 30% of the capital, sovereign wealth funds (SWFs) from Saudi Arabia and Abu Dhabi have committed roughly 60% of the capital. For context, we estimate that during 2016, private companies raised roughly $100 billion in capital and that the 20 leading VC firms have less than $50 billion in dry powder on their hands. We continue to believe that SWFs are increasingly interested in private tech growth companies. While Sand Hill VCs have developed a love-hate relationship with such “tourist investors,” we think nontraditional investors such as SoftBank have the dry powder to exert their influence on the private tech investment landscape over the next few years.
More first-time funds will be raised
2016 hit an historic low, with only 42 first-time funds that closed, compared to 94 in 2015. Fundraising can also take a while; especially for new managers it can take anywhere from 12 to 24+ months before a close. All signs point to a backlog.
Thus, I expect the number of first-time funds to go up in 2018 as managers who started raising in 2016, and a handful of those beginning to raise this year, will close their funds in the next 12 months. That said, I don’t anticipate 2018 to return to the halcyon days of 2014 when 120 first-time funds were raised. There is a notable noise to signal challenge for LPs given the hundreds of microfunds raised over the past few years coupled with LPs’ desire to see how the fund managers they have backed in the past few years mature before adding new funds to their respective portfolios.
M&A exits will keep climbing both in volume and value
For tech companies looking to exit the private market, the prospect of getting acquired may well be more promising than going public (and trading low) or raising a down round. With record amounts of cash on corporate balance sheets (potentially even more if corporations are motivated to repatriate off shore funds by the incoming administration) and significant dry powder in PE funds, there are lots of reasons to believe both corporations and PE shops will continue to acquire IT assets.
Moreover, we believe non-traditional buyers will keep jumping into the game of acquiring mature startups in hopes of getting an edge on innovation (e.g. Walmart, GM, Unilever). Thus all things considered it appears that 2018 for Venture Capital looks better than 2017.
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