What Just Happened – Part II?

The National Venture Capital Association released the 2Q14 fundraising data a few weeks ago which makes for fascinating reading when compared to the 2Q14 VC investing data. While sentiment is meaningfully improved from the depths of the Great Recession of a few years ago, analysts were surprised that the amount of capital raised was actually down 19% from 1Q14; that is 78 venture firms raised $7.5 billion (data are slightly revised since the initial press release) as compared to 63 firms and $9.1 billion in 1Q14 and 55 firms and $3.3 billion in 2Q13. Obviously quarter-to-quarter variations are interesting but may not tell the whole story.

Most VC’s will tell you that conditions have improved – clearly with greater liquidity (i.e., distributions to LP’s) from stepped-up IPO activity and M&A transaction volume comes greater investor confidence. Some also expected to see a greater impact on fundraising volumes due to the ability for firms to now publicly solicit accredited U.S. investors (see 500 Startups) but that has yet to be a meaningful contributor to overall activity. Arguably the rising tide is not lifting all boats in the same manner. The VC industry continues to be dramatically redefined and the battle between large and small firms continues – the average size fund raised was $95 million, while the median was $28 million thus hinting at the underlying structural changes.

  • The top ten funds raised this past quarter collected $4.4 billion or nearly 60% of the total amount raised, implying an average fund size of…wait for it…$440 million; this is skewed by the largest fund raised by Norwest Venture Partners clocking in at $1.2 billion.
  • There were only nine funds raised between $150 million and $300 million, which had been the “bread and butter” fund size of the VC industry, especially if you think in terms of the “$50 million per partner per fund” metrics.
  • There were 59 funds raised that were less than $100 million in size and in aggregate they collected $1.5 billion (average fund size ~$25 million)
  • Notably there were 38 funds raised which were less than $25 million in size (and of that, 24 were less than $10 million in size – so nearly a third of the funds raised were tiny).
  • The 20 first time-funds raised $666 million (bad omen?); the largest of which was $172 million (Lightstone Ventures) – the average size of first-time funds was $33 million. Maybe LP’s are not really “all-in” yet which underscores the stickiness of existing venture brands.

What continues to be so confounding is the duration and depth of the “VC funding gap.” The venture industry for more than six years

Funding Gap 2Q14
Global VC IRR August 2014

invested at a pace far outstripping its ability to raise new capital. Clearly the lines below must converge at some point, and rather dramatically. Part of this can be explained by non-VC firms investing actively in VC deals – that is hedge funds and angels who would not normally be counted in the funds raised data. Simply annualizing volumes through the first two quarters of 2014 it appears that the VC industry is on pace to raise $33 billion and yet the industry looks like it will invest close to $45 billion. That gap existed before 2008 and has endured.

Funding Gap 2Q14

Interestingly this phenomenon is not in all markets. In fact Chinese VC’s invested $2.8 billion into Chinese companies this past quarter (as compared to $1.4 billion in 2Q13) while Chinese VC firms were able to raise 13 new funds totaling $3.1 billion.

So what should we expect for returns from this investment period? While it is obviously too early to call it, the VC industry has had trouble in the past absorbing too much capital, too quickly as suggested in the below analysis (prepared by Michael Nugent at the Bison Group) which looks at the average size commitment by LP each year; LP’s tend to pile into VC funds on the heels of strong vintage years. Extraordinary returns tend to be highly correlated to robust public capital markets but are also impacted by over-eager private capital markets investing at arguably an unsustainable pace.

Global VC IRR August 2014

Good thing the level of innovation is unprecedented today, entrepreneurs are addressing global markets while building economically sound businesses – now should be different – or not.