Wider Venture Funding Gap Raises Troubling Questions
This week, Oxfam released its annual study of inequality around the world, which showed that there are actually 62 people who possess as much wealth as the 3.5 billion people in the bottom half of the world’s income scale. Five years ago, that number was 388 people.
And all of this is against a backdrop where the global economy has more than doubled over the past 30 years, reaching approximately $78 trillion in size. Interestingly, the top 1 percent is expected to control more wealth than the remaining 99 percent by the end of 2016.
And in related news, last week the National Venture Capital Association (NVCA) released its own study of “inequality”—I mean the fundraising statistics from the fourth quarter of 2015—which showed that 46 funds totaling $5 billion were raised, bringing the annual total for 2015 to $28.2 billion. Quite clearly, the fundraising pace over the second half of 2015 markedly slowed from the first half of the year. Notwithstanding that, 2015 was still meaningfully ahead of the 10-year trailing average of $23.4 billion, although it was modestly below the 2014 total of $31.1 billion.
There is the litany of usual suspects as to why this may be occurring: rising interest rates, China deceleration, lack of sustainable and compelling IPO activity, and general economic conditions. Standard & Poor’s recently announced that the outlook is worsening for 17 percent of the companies rated by S&P, as compared with only 6 percent that are improving; this is the largest spread since the Great Recession. But undeniably, the venture capital industry also has an “absorption” issue; that is, only so much capital can be deployed productively given the industry structure, especially in the face of inconsistent liquidity.
As of the end of 2014, the NVCA counted 1,206 existing funds managed by 635 active firms. The total assets under management (AUM) at that time was estimated to be $156 billion, of which $85 billion was managed in California, $20 billion in both New York and Massachusetts, with only $3 billion in Texas. The high water mark for AUM was $289 billion in 2006, which implies that the industry was nearly cut in half over the course of the Great Recession, plus or minus. And yet, given that contraction, there are hundreds of firms chasing after innovative market opportunities, which often leads to far too many competitors in small niche, but emerging, marketplaces.
To underscore this dichotomy, some interesting jewels are buried in the fourth quarter fundraising data:
• Of the 46 funds raised, 20 were deemed “first-time” managers, which raised $424 million (or under 9 percent of the total).
• The average size fund raised was $109 million, although the median (a better barometer) was only $23 million.
• The largest first-time fund was $90 million.
• The largest fund raised (Tiger Global) was $2.5 billion, or 28 times larger than the largest first timer.
• The top-five funds raised $3.7 billion (or 73 percent of the total).
• The top-10 funds raised $4.3 billion (or 86 percent of the total).
• Fifteen funds raised less than $10 million.
• The smallest fund, maybe in recorded history, was DunRobin Ventures, weighing in at $50,000.
And now for the rest of the story…
Unlike the amount of capital raised in 2015, the annual amount invested by VCs increased significantly to total $58.8 billion. Interestingly, the fourth quarter saw $11.3 billion invested in 962 companies, which were both modestly down from third-quarter levels, and in fact, the amount invested was the lowest in the past six quarters. There was significant investor enthusiasm directed at “tech-enabled” business models in the financial services, healthcare, and consumer sectors, potentially suggesting that those companies may have an easier time raising follow-on capital once the unit economics are proven. The phenomenon of “mega” venture rounds continued in spite of a weak IPO market in the second half of 2015, as there were 74 of them in 2015.
The “funding gap” continued to widen, which may be more of a reflection of definitional challenges as the boundaries blur between true early-stage venture capital investing and mutual and hedge funds investing “down market” in large mezzanine rounds of venture-backed companies, which would skew the aggregate funding data. In any event, this gap is troublesome should the amount invested decrease precipitously fast, leaving many companies stranded. Notwithstanding the possible “data integrity” complication to the analysis, there were also … Next Page »