Boom – Venture capitalists seem to be operating in a different world to other investors. For now
2015 may have proved a tough year for most investors and asset classes but apparently nobody has told the venture capitalists. According to the latest Venture Pulse analysis of venture funding by CB Insights and KPMG, the third quarter of this year saw venture capital-backed companies raise $37.6bn (£24.4bn) globally across just shy of 1,800 deals.
More remarkable still, the $98.4bn of funding venture capital-backed companies have secured in the first three quarters of 2015 is already 11% up on the global total for the whole of last year and nearly double the 2013 tally. The report also notes that large deals are driving funding trends with what it calls “mega-rounds” of $100m-plus accounting for a “substantial part” of third-quarter activity.
Another feature of the Venture Pulse report is the continued rise of the ‘unicorns’ – venture capital-backed businesses with valuations of $1bn-plus, about which we have expressed some concerns in Hit and myth. The third quarter saw the creation of 23 such beasts – 17 in the US alone – bringing this year’s total to 58 and counting, compared with 38 in all of 2014.
From articles such as Carry on regardless and Get your coat, regular visitors to The Value Perspective will also be aware of our concerns about the bubbly levels of confidence in some markets, which have been encouraged in no small measure by cheap debt, and all these issues came together in a recent FT article, unambiguously entitled The subprime ‘unicorns’ that do not look a billion dollars.
“A handful of these businesses will become the great, enduring companies of tomorrow,” it notes. “But a good number seem the flimsiest of edifices. Forget the fact that some of these valuations are illusory because the most recent investors have structured their investments as debt in all but name, meaning that they will stand to profit even if the company is worth far less.”
The article also highlights the “false sense of security provided by the private markets at a time when interest rates are negligible and many investors, particularly those who are either new to technology or have short memories, are all too willing to back start-ups whose premises house several baristas and where a dozen blends of tea (not to mention the sea-salt flavoured chocolate bars) are de rigueur”.
According to another FT article, this perception of a seemingly inexhaustible supply of venture capital funding, which the current environment is creating, is even raising the spectre of ‘moral hazard’. In effect, founders may see little in the way of potential downside for either themselves or their fledgling businesses and believe that, should things go wrong, they can simply walk away and do something else.
The moral hazard created by buckets of start-up funding () begins with an anecdote about “a particularly obnoxious and overconfident founder” being asked by an investor how he intended to make money. His reply was the less than reassuring “I sell equity to venture capitalists” – and yet, the article reports, “his three-year-old company has secured several million pounds in funding”.
To finish where we began, the Venture Pulse analysis brought the following comment from CB Insights CEO Anand Sanwal: “Despite the chatter about an overheated market, the appetite for investment into fast-growing private start-up companies remains insatiable. The third quarter of 2015 marks another dotcom-level high for funding and this has become the new normal it seems.”
He also suggested that “investor ‘FOMO’ continues to be a key driver of mega-financings and doesn’t look to abate anytime soon”. In case you do not recognise the acronym, ‘FOMO’ stands for ‘fear of missing out’, which was of course a key ingredient of the dotcom bubble that burst in early 2000. The venture capitalists may get the message soon enough.
Investment Specialist, Equity Value
I joined Schroders in 2010 as part of the Investment Communications team focusing on UK equities. In 2014 I moved across to the Value Investment team. Prior to joining Schroders I was an analyst at an independent capital markets research firm.
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