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Venture Capital Industry: At the Dawn of a New Era

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2015 has been a banner year for BootstrapLabs. During the past 12 months, we led our first Series A round in an exciting FinTech company, all our portfolio companies raised follow-on funding at higher valuation and we continued to expand our Expert in Residence team to support our portfolio companies.

We believe that technology is a driving force for positive change in the global economy, in society in general, and our daily lives in particular. We continue to be impressed by the talent and passion our founders demonstrate every day and look forward to continuing investing in disruptive technology companies that can transform the way we live, the way we work, and the way we connect with the world around us.

Many believe private companies are overvalued, while others think the next tech bubble is coming. At the same time we see that seed stage investments, where BootstrapLabs focuses, are more vibrant and exciting than ever (e.g., a $25K seed stage investment in Uber would be worth ~ $125M at the $40B valuation mark; even if you assume that Uber is worth $1B, it would still be an investment worth ~ $3M, or 125x the invested amount).

BootstrapLabs is “deep in the stack” alongside its founders day after day, driving the venture market momentum forward. Our global innovation discovery network, combined with our Silicon Valley investment and execution model, provides us with a unique vantage point on what is happening in every corner of the world. Here is what we are observing:

The HOT tech industry is attracting new, mostly late stage, institutional investors that need to invest tens of millions per deal to move the needle.

In 2015, over 566 deals were financed by investment banks, mutual funds, hedge funds, asset managers, and others, while 78% of the deals over $1 Billion have been lead (read priced) by non-VC investors.

Rounds into Tech Companies

Rounds into Tech Companies

Late stage deals are becoming more competitive and less price sensitive due to a combination of i) pent-up demand driven by lower public market returns and the relative rarity of such high growth private technology companies and ii) more financial engineering and deal structuring that aims at lowering the risk for investors, independent of valuation paid (e.g. preferences, ratchets, dividends, etc.) Arguably, these higher valuations are behaving more like “out-of-the-money strike prices” of call options rather than rational valuations driven by operational and technological performance. The chart below outline the dramatic increase in valuation in the later stage as well as the larger amount of money invested by these non-VC investors.

late stage private company median valuation

late stage private company median valuation

Median round size for mid & late stage startup rounds by investor type

Median round size for mid & late stage startup rounds by investor type

There are also NEW sources of capital targeting the Tech Industry via Equity Crowdfunding and platforms that are driving retail investors into the venture market.

Global Equity crowdfunding amount

Global Equity crowdfunding amount

As these platform emerge and private companies can do “public offering of private equity”, secondary market for private equity trading/exchange will gain momentum and importance. One big signal of such trend was the recent acquisition of SecondMarket, the leader in the space by Nasdaq.

Why are non-VCs investing in the tech space?

Startups are staying private longer prior to IPOs today, which means that private investors are making the most of the value from their investment during the pre-IPO period. Traditional public investors, like hedge funds and mutual funds, are starting to realize that in order to capture more value they have to move earlier in the game and start investing in pre-IPO rounds (Private IPOs). See this prior post from Ben Levy, Co-Founder of BootstrapLabs on How to Milk a Unicorn…

Also, traditional VCs have realized that they have to invest earlier in the cycle in order to maximize their investments and not become irrelevant themselves in a world that is changing fast.

Value is Captured Earlier

Because it takes a lot less capital and people to build a proven and scalable product/model, early stage investment has become the most important and possibly the most lucrative part of the value creation chain in our opinion.

late stage valuation

late stage valuation

Later, Access is King

Late stage investors will only succeed if i) they can identify outliers early and ii) they can win a seat at the table during the next fundraising round (hint: money is not enough)

These structural changes, combined with deregulation, have created a once in a lifetime opportunity to form and scale new ventures, as well as new VC firms to finance them. As shown by this recent research report published by Cambridge Associate, more than ever before in the history of the Venture Capital industry, newly formed VC firms have been able to invest and capture some of the top performing startups.

Yet, the opportunities for individual investors remains limited as the industry is shifting to a new model/structure. Similar to the situation with established VCs and hot startups, an individual investor better gain access to future hot new VC funds/managers now, because the best performing funds will have limited access for existing LPs and possibly no access for non-existing LPs in their future funds.

Quality vs Quantity

The number of startups created each year has exploded and will continue to grow quickly as the cost of building technology companies has decreased by at least 10x in the last 20 years, and success stories continue to be blasted across the media as a source of inspiration and validation. The problem will be to identify the good startups as the noise level continues to rise.

Early stage growth no longer signals long term success and the ability to iterate, build and improve your product has become one of the most valuable success skills in the tech space. At BootstrapLabs we excel at finding top talent, bringing them to the best ecosystem (Silicon Valley) and supporting them in their full-cycle “build-measure-learn” iterations.

Innovation is a constant requirement for corporations to remain relevant and it is a pillar of subsistence for our society. Tech innovation will continue to grow and generate outlier returns for the best VCs (and their investors) in the industry. As someone recently mentioned to us “VC is at a dawn of a new era”. Just look at these numbers:

  • 3.6 Billion unique mobile subscribers in 2014
  • 2+ Billion people connected on major social media networks (1.4B FB, 250M TW, 300M LNKD, 300M Instagram)
  • 120x faster online speed (6.7 Mbps US average today)
  • 243 million machine-to-machine connections
  • 50 Billion connected devices by 2020
  • $1.7 Trillion e-commerce spend

The total of all the Unicorn valuations today is worth about half the value of Apple. Some of them will go public, some will be acquired. Apple could actually acquire most of the Unicorns and still have billions in its bank account to spare.

The slow growth in the number of IPOs is a consequence of a historical switch and the growing importance of innovation. Companies need to invest most of their cash flow in innovation, while public market investors expect short term revenue first. Many startups are building for long term success, and if they go public too early they will be unable to maximize their innovation or opportunity. As Marc Andreessen said during a recent interview: “It’s not a tech bubble, it`s a tech bust”… many of the innovation and technology companies are still undervalued and we are strongly optimistic about the great future in front of us”. So is BootstrapLabs!

Venture Capital Disrupts Itself: Breaking the Concentration Curse

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Please note this is a short version of the Venture Capital Disrupts Itself: Breaking the Concentration Curse report published by the Cambridge Associates. At the end of this blog post you can find the link to access to the original file.

 

Venture Capital Disrupts Itself: Breaking the Concentration Curse

The Old Wives Tale … Conventional investor wisdom holds that a concentrated number of certain venture firms invest in a concentrated number of companies that then account for a majority of venture capital value creation in any given year. Therefore, LPs seeking compelling venture capital returns should only commit to a handful of franchise managers. And those are precisely the managers that do not offer access. Thus, LPs are “cursed” and will never experience the differentiated return pattern offered by venture capital exposure.

… Is Flawed. As the venture capital industry and technology markets have evolved and matured, however, more managers are creating significant investment value for LPs, with value increasingly created through companies located outside the United States and across a range of subsectors. Specifically, our analysis of the top 100 venture investments as measured by value creation (i.e., total gains) per year from 1995 through 2012, an 18-year period, demonstrated:

  • an average of 83 companies each year account for value creation in the top 100 investments in the asset class for each year;
  • in the post-1999 (i.e., post-bubble) period, the majority of the value creation in the top 100 each year has, on average, been generated by deals outside the top 10 deals;
  • an average of 61 firms account for value creation in the top 100 investments in venture capital per year; and
  • the composition of the firms participating in this level of value creation has changed, with new and emerging firms consistently accounting for 40%–70% of the value creation in the top 100 over the past 10 years.

In short, the widely held belief that 90% of venture industry performance is generated by just the top 10 firms (which our analysis shows was somewhat relevant pre-2000) is a catchy but unsupported claim that may lead investors to miss attractive opportunities with managers that can provide exposure to substantial value creation.

You can access the full Cambridge Associates report here.

How to Milk a Unicorn… No Really, How?

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Victoria Silchenko recently posted an article on LinkedIn, Confession of Venture Capitalists: How to milk a Unicorn where she interviewed some high profile VCs and Private Capital experts on the recent “private IPO” trend. Great topic, catchy title and excited that BootstrapLabs will be joining the discussion live at her upcoming Global Alternative Funding Forum on November 6th in Los Angeles. Don’t miss it!

Having lived in Silicon-Valley for over 16 years as an entrepreneur, investment banker and tech investor, I have had the privilege to work with David Weild, count Will Bunker among my friends and co-investors, and have met with both Tim Draper and Andrew Romans.  And I cannot help but wonder what the impact of these billion dollar companies going for Private IPOs will be on the liquidity cycle of Venture Capitalists.

I will skip some of the basic premise nicely outlined (or should I say revealed) by David Weild on his research paper, Why are IPOs in the ICU? and outline some of the basic benefits provided by standard IPOs:

  • Public visibility with main street on a global scale,
  • Increased trust with partners and providers,
  • Promise of cheaper and faster access to capital to grow the business, make acquisitions and attract talent,
  • Ability to offer liquidity to existing investors that had supported the company until then (average startup age at IPO is 7+ yrs lately, and trending up) as well as employees. These liquidity events do not happen at the IPO stage but usually during a Follow-On (FO) offering, as main investors and management teams are considered insiders and are under lock-up agreements for 180 days post IPO (and subject to trading limitations thereafter).
  • Promise of rapid stock price appreciation driven by company’s growth and positive wall street analyst coverage

Now, let’s take a look at the benefits provided by “Private” IPOs:

  • Unicorns are enjoying tons of (free) publicity, which could certainly qualify as the equivalent to going “public” from a notoriety stand point,
  • While a lot less public (financial and operational) information exists about these Unicorns due to their private status, it is fair to assume that partners and customers alike are more inclined to provide them with the same level of trust, credibility and most favored nation terms as if they were publicly listed companies,
  • In the current market, one could easily argue that you can raise faster, cheaper and even more capital in the private market if you are a Unicorn vs. a company filing for an S-1; and the best part of it is not being subjected to daily Wall Street scrutiny as Twitter has painfully experienced in recent months,
  • This one gets interesting. There is little information out there but these large “Private” IPO rounds often include some – at least partial – liquidity for the founders, early investors and sometimes employees. The average Unicorns’ age is about 9+ years according to Beau Laskey at SVB , which is longer than the life of most VC funds. As such, it should come as no surprise that VCs, especially the ones that came in early, would seek liquidity in those later stage mega rounds.

Unicorn are not overnight successes. As the saying goes in Silicon Valley, Overnight Success takes 10 years! 

 

BootstrapLabs-SVB-investment

BootstrapLabs-SVB-investment

 

  • Valuations are sky-rocketing in the private market once a company reaches Unicorn status…and one has to wonder if it is due to sheer speed of execution and the breath-taking growth rate experienced by these startups, or a demand driven phenomenon where every deep pocket investor wants to ride this rising giant sooner rather than later, and deploy a large chunk of capital into it for a 1.5-3x return. These returns sound really good, especially when you are able to deploy over $100M at a time after some of the major risks appear to have been removed. In comparison, public market returns have eroded and it is getting harder and harder to find alpha at scale.

Unicorn Valuation Surge in the Private Market:
This is a one year old chart: Uber is now worth $10Bn more! 

Valuation Surge

 

Are Later Stage Investors Valuation Insensitive Due to their Preference?

Andrew Romans had an interesting point in Victoria’s article in that the last money in gets liquidation preference (and sometimes anti-dilution protection in the event of a down round). That would basically make those investors valuation/price insensitive as they would get their money out first in case of trouble and that the valuation of these companies would likely not fall below their investment amounts to begin with. But in case of Qualified IPOs, these liquidation preference would go away and even if the opening price is higher than the last round of funding valuation,  nothing would prevent the stock from tumbling down. See this good post on IPO down rounds.

 

Are Insiders Allowed to Lock-in Profits Quietly?

Another risky dynamic at play here is the liquidity provided to insiders as part of these later rounds. In a public setting, if an insider sells his shares he would need to disclose it to the public; but in those mega rounds of financing,  only major investors are posted on the transaction structure, leaving out of the loop a lot of people inside and obviously outside of the company. Wouldn’t you think that knowing that the founder(s) of your company have locked in some of their gains would be important news?

 

Potential M&A Suitors Evaporating by the Minute

While M&A still represents between 90 and 95% of the return on capital for VCs, the list of potential acquirers for Unicorns is shrinking by the minute as their valuations are significantly higher then those of the very incumbents they seek to disrupt. As an example, Group Accor ($9Bn market cap.) can no longer buy AirBnB ($25Bn).

1B Exit ChartBn Exit vs Valauation

Ultimately the Losers are Public Institutional and Retail Investors

Maybe a good way to look at what is happening is by drawing a chart with valuation against time, with a typical Unicorn curve, pre- and post- IPO.

private vs public

In that context, it is pretty clear that a lot of the growth and value that was once captured by public investors (including you and I as retail investors), is now being captured by the late stage growth and cross-over investors, while increasing the risk/return profile of Unicorns in the public market once their valuation has been “maxed out” in the private market.

VC firms are flushed with $75Bn of dry powder
so you can bet they will want to party on!

VC Overhang

I remember ringing the bell at the NYSE in 2009 with my startup InsideVenture, for the launch of our new product, dubbed “HPPO” for Hybrid Public Private Offering. At the time, VC-backed IPOs and Wall Street in general had ground to a halt after Bear Stearns and Lehman went down. We talked about ways to fix the IPO market and “orderly transition” of the cap table with top VCs such as Ray Rothrock from Venrock and Scott Sandell from NEA.

Ringing the Bell in 2009 at the NYSE for our Product Launch:
HPPO – Hybrid Private Public Offering

NYSE_HPPO

With new regulations such as Reg A+, allowing private companies to crowdfund up to $50M and trade their shares on secondary markets, it looks like the future might be just that, a world where public investors are finding their way back into ventures, earlier in the growth curve!

As Bill Gross told us last Thursday, “Timing is everything”…we were just 7 years too early!

Learn how to be a successful Angel Investor

Learn how to be a successful Angel Investor!

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Learn how to be a successful Angel Investor

The venture world is changing profoundly and over the next few months we will see a huge increase in “big” seed stage (Pre Series A) deals.

As Ben Levy, co-founder of BootstrapLabs, mentioned in his recent blog post “Seed is the New Series A”, we will over time see more and more seed stage investors creating syndicates and inviting fellow angels to co-invest in their deals.

The number of angel deals, crowdfunding platforms and micro VCs is growing dramatically.

Number of active Micro-VCs

Number of active Micro-VCs

*the majority of these funds of this size are closed without any traditional institutional LP backing. Source: CBInsights; graphic BootstrapLabs.

Learning the ins and outs, strategies, and best practices needed to be a successful angel investor is not easy, but here are a few steps you can follow in order to get started in this exciting new world of “private is the new public”.

Angel investing is often considered by many people to be like a poker game, but with the new market structure and the emerging models of crowdfunding, I believe that Angel investing is becoming more of a team game than a solo gambling endeavor.

One of the most important steps for an Angel Investor is gaining access to quality investment opportunities and spreading their risk by diversifying investments (into a minimum of 10/15 deals if you are active and closer to 30 if you are passive). To invest in 10 good deals you should meet and evaluate at least 100 startups, and this is not easy thing if you are doing angel investments on the side!

You should probably not make 10 investments at once or in a short time span by the way…each deal you invest in will teach you something, and you definitely want your later deals to benefit from your early ones.

This is also why joining a syndicate on a crowdfunding platform or investing alongside or in a Venture Capital fund is recommended. Participating in deals with experienced and expert investors will reduce your risk and save you the time of doing due diligence.

In any case, if you have not already done so, the first thing you need to do to become an angel investor is to verify your Accredited Investor status for a variety of reasons, not the least of which is to make sure the startups do not get into hot water with the SEC for selling private securities to “naive” investors.

To be an Accredited Investor you need to be eligible with one of the following criterias:

  • Individuals with annual income over $200K (individually) or $300K (household) over the last 2 years and an expectation of the same this year
  • Individuals with net assets over $1 million, excluding their primary residence (unless more is owed on the mortgage than the residence is worth)
  • An institution with over $5 million in assets, such as a venture fund or a trust
  • An entity made up entirely of accredited investors

For more information read the SEC documentation.

What Angel Investing means?

Angel investing is buying equity (or convertible securities that can be converted into equity) in a startup company at the earliest stage of a company’s lifecycle. These investments are high risk but also potentially the most profitable since investors benefit from lower valuation and their relatively small check still buys a decent amount of ownership. On that note, angel investors should not aim to “own” or “control” a business if they want to ensure the long term success of their investment. If you should feel you have to do this for the company to succeed, you might be better off investing in another company altogether.

Why is access to good deals limited today?

Because good deals are mostly funded by people who do angel investing as a full time job, and includes a few friends in their trusted network, the financing round will be filled very quickly and will be closed before anyone else even knows about it.

Today, competition is very high in this space and the majority of good startups are participating in accelerator programs and/or having their deals syndicated on platforms like AngelList by expert seed stage angel investors and even Micro-VCs.

Why do startups need Angel Investors?

To pay for their initial expenses and to provide capital to build the first version of their product. Also for many startups, finding an Angel Investor is a good way to prove that their endeavor is or will be valuable. Validation by expert and successful Angel Investors is considered by other angels or seed stage VCs as almost a requirement these days to rise above the noise level.

From a startup’s perspective, it is very important to have respected and value-add Angel Investors on their cap table at the beginning of their journey, especially when the time to raise another round arises, and it will always be sooner than a founder would like to admit.

What does the typical Angel Investment Strategy look like?

As described above, one of the most important steps to becoming a successful Angel Investor is having access to good deal flow. Angel Investing is a high risk investment and you have to invest in at least 10 deals (would recommend even more with small checks) over time in order to diversify your risk.

While the typical Angel Investment is between $5K to $25K; the return of a successful Angel investment can be up to 500x but you will also face the very real fact that 50% of the investments you make will have a low or even zero return, as many startups fail.

To reduce your risk and increase your chance of investing in the next unicorn at an early stage (500x return) as a new Angel Investor, the best thing to do is to participate in deals with other trusted investors or invest a bigger check into a VC to start building your network and knowledge in this space!

Learn more about BootstrapLabs Syndicate here

I will publish more articles regarding this topic soon, so if there is anything you would like to add or ask, please contact me @luigicongedo !

Also I would like to recommend this NY Times article to learn how the world of angel investing has changed in Silicon Valley in the last decade.