1Q VC Data: What Just Happened?

5/21/14Follow @greels1

The National Venture Capital Association recently released data on first-quarter investment activity, which always makes for an interesting read, at least on long plane rides. Point of fact, this past quarter was exceptional in many ways—and arguably somewhat unexpected. The headlines read that $9.5 billion was invested in 951 companies, an amount we have not seen since the fateful second quarter of 2001. But it is what is beneath the headlines, buried in the reams of data, which paints a more nuanced picture.

Undoubtedly, the level of investment over the first 90 days of 2014 was unprecedented. In last year’s fourth quarter and first quarter, the amounts were $8.4 billion in 1,112 companies and $6 billion in 916 companies, respectively. Clearly, the stepped-up investment pace throughout 2013 extended into 2014 and tracked the increased liquidity VCs witnessed along the way. Given the marked public stock market volatility which set in this past February, it would not be surprising to see activity tempered over the next few quarters, suggesting that we probably are not on an annual investment pace of approximately $38 billion for 2014. For context, annual investment activity from 2011-2013 averaged about $28 billion.

Overall, certain important themes are emerging in the most recent quarterly data: VCs are clearly investing in later-stage companies, VCs are investing in businesses that have meaningfully less technology and development risk, and round sizes have spiked, most notably by “mega rounds” of hundreds of millions of dollars—which probably skews the data somewhat.

So what jumped out at me?

—Dramatic decline in seed investing: Only $125 million was invested in 41 seeds (average deal size $3 million) in the first quarter, as compared with $347 million in 69 companies (average size $5 million) in the prior quarter, which is a decrease of 64 percent. The advent of the micro-VC and “super angel” investor from a few years ago may be running its course.

—Where did the seeds go? Early-round financings were $2.9 billion (451 companies, average size $6.4 million) of the activity, which is a meaningful step up from $1.6 billion (420 companies, average size $3.7 million) in the same quarter last year. Not surprisingly, many of the seeds from prior periods have graduated onto the next phase of growth.

—Expansion-stage financings really spiked up: In the first quarter of 2014, $3.9 billion was invested in 274 companies (average size $14.3 million), which was over 40 percent of all investment activity for the quarter, compared with $2.1 billion in 239 companies (average size $8.6 million) in the prior-year period. Quite clearly, VCs are doubling down and supporting those seeds, which appear to be breaking out with larger rounds.

—The software category sucked the air out of the room: Software was 42 percent of all financing activity and far and away the largest of the 17 categories tracked. In the first quarter, $4 billion was invested in 414 software companies (average size $9.7 million), compared with $2.3 billion in 361 companies a year ago. Arguably, this activity came at the expense of other categories such as telecom, semiconductor, networking and equipment, and electronics, which barely registered this past quarter (only $20 million was invested in networking and equipment, for instance).

—Services investing surged: All categories of services (business, IT, financial, and consumer) more than doubled from a year ago and measured $1.7 billion invested in 126 companies (average size $13.4 million). This is somewhat surprising given the historic VC aversion to services business models, as they “don’t scale” and have lower gross margins. Are VCs investing in safer companies? Clearly they have all but avoided capital-intensive hardware businesses.

—Healthcare held its own: In the first quarter, $1.7 billion was invested in 182 companies, compared with $1.5 billion in 182 companies and $1.9 billion in 252 companies in the first quarter and fourth quarter of 2013, respectively. Overall, though, healthcare (biotech, medical devices, and healthcare services) captured only 15 percent of all dollars invested.

—Which category was the dark horse? Over $250 million was invested in retailing this past quarter, compared with $17 million in the same period last year.

The shuffling between stage of investing and industry categories is always illuminating. VCs seem to be investing later to get closer to liquidity, perhaps to bolster their own fundraising stories as they set out to raise the new funds, but to also exploit the robust public capital markets. Arguably, the rotation among industry categories reflects prior investment performance by category. Hardware-centric businesses and those with long product development cycles have chronically disappointed investors; where would biotech be right now, were it not for the “biotech bubble” we witnessed over the past six months?

The other barometer of risk-taking is first-time financings, which tracks companies receiving venture capital for the first time. Some interesting developments jump out of those data:

—First-time financings in the first quarter totaled $1.2 billion, or 13 percent of all investment activity, which compares (poorly) with 21 percent and 19 percent in last year’s first quarter and fourth quarter, respectively.

—Early-stage first-time financings constituted $830 million of that activity, which was down slightly from $887 million in the first quarter 2013, although expansion-stage deals showed a more marked decline to $135 million from $227 million in the prior quarter.

And I always get a kick out of some of the other data buried in the report…

—Twenty-three states had three or fewer venture investments in the first quarter. In fact, seven states had zero.

—California captured $5.5 billion of the $9.5 billion invested, which was up substantially as a percentage of total dollars invested from the same period last year: 58 percent, compared with 48 percent a year ago. That’s further concentration of activity, although for those of us not in California, it is important to note it is a huge state!

—Hawaii, on the other hand, had two venture-backed investments that raised in total $271,000. How cute.

—The top-10 venture investment rounds in the quarter were at least $100 million in size (are those venture deals, really?), with Dropbox’s $325 million registering as the largest raise. And there were no healthcare companies on this list. These mega-rounds reflect funds with either too much capital or a strategy to anoint winners and thereby chill any competitive companies being launched. But will they drive great returns? Stay tuned.

This essay originally appeared on Michael Greeley’s blog and is reposted by permission.

Michael Greeley is a General Partner at Foundation Medical Partners. Follow @greels1

By posting a comment, you agree to our terms and conditions.

  • Steve Carver

    Looks like they’re missing some data. PitchBook Data shows 1,072 VC transaction completed in Q1 2014 with a total of $12.3B (versus NVCA’s 951 deals for $9.5B). Q1 2011 saw more activity with 1,319 deals for 12.3B.