Q3 Venture Capital Marks the Home Stretch for 2020
October 26, 2020
EisnerAmper Managing Director of Capital Markets Alan Wink looks at the VC landscape going into the home stretch of 2020 and the rise of special purpose acquisition companies (SPACs). Alan is joined by Michael Rosenberg—a director in the firm’s Process, Risk, and Technology Solutions—to discuss the impact of the Committee on Foreign Investment in the United States (CFIUS) on VC investment.
DP: Doing good, hanging in there. I hope you and yours are the same. So couple of weeks from an historic election, we're coming into the home stretch of 2020. Tell us where we are with the VC market.
AW: It's funny, the pandemic has certainly stopped a lot of businesses, but I don't think I would put venture capital into that category. With the pandemic going on, I think people thought that activity would certainly slow down a little bit. It certainly hasn't. The third quarter of 2020 saw venture capital investment of almost $38 billion, and ironically that even exceeded the amounts invested in Q1 and Q2. Later stage deals certainly continue to dominate about 70% of the capital invested in Q3. We're in later stage deals, series C and beyond. VC exits continue to grow. They're way up. Actually, in the third quarter we saw 104 billion of venture capital backed exits, which was actually the second highest quarter on record. Four IPOs accounted for about 65% of the VC backed exits.
In fact, Q3 saw 13 IPOs of companies with values greater than a billion dollars. Not everything is rosy though. The larger deals certainly are occurring. I think you're continuing to see a slow down with smaller deals, including angel and seed capital deals. And probably the ones suffering the most are entrepreneurs looking for their first round of funding since first time financing for entrepreneurs reached a 10-year low in quarter three. All in all, very good quarter, probably has exceeded people's expectations.
DP: Okay. Now, a hot topic in your world is SPACs, tell us a little bit about those.
AW: They certainly have been around for a long time, but they really are starting to gain some traction. And simply stating, what is a SPAC? A SPAC, it really means a special purpose acquisition company, or it's also referred to as a blank check company. And really it's a company with no commercial operations that is formed to raise capital through an IPO with the singular purpose of acquiring an existing company. Really, 2020 has been a record year for SPACs. Over $41 billion have been raised through SPACs for the first three quarters of the year. You ask, who are investors in SPACs? Investors in SPACs range from other private equity funds to the general public. The other thing that you should know about SPACs is once the money is raised, they only have two years to complete an acquisition or else the funds have to return to the investors, but it really has become a very vibrant market as another way for companies to go public.
DP:Why do you think there's this increase in popularity all of a sudden?
AW: I think it's just the ease. They're raising money without a company in mind to acquire. It just shows the frothiness of the market, that there's so much capital out there looking to find a home.
DP:So looking forward a little bit, what activity would you like to see in the upcoming quarter, quarter four that might indicate an economic recovery has taken root? On the other hand, what types of data would give you cause for concern for next year?
AW:It's interesting, so much of venture capital is related to technology. And technology has been such a driver of this economy during COVID-19, and I'm afraid to see what our economy would look like if we didn't have these great technology companies that were started and grown over the last 10 years, that allow us to work from home, allow us to stay healthy through telemedicine, allow us to complete financial transactions without being face to face. So I think you're going to see that continuing, I think we've seen many, many years of changes in the way we do business over a relatively short time. I think what we're seeing, which is really kind of interesting, we're seeing an uptick in venture capital investing. We're seeing a large increase in exit opportunities for VC backed companies, both being sold to strategics and also through IPO's and SPACs.
You're seeing limited partner capital being raised at very high levels. Everything seems to be working. And I think part of it is that people are enamored with technology, people don't want to miss out on the next thing. So I think we're going to continue to see that happening just because of the amount of capital in the marketplace. And people are literally excited about investing in technology. And I don't think that will change depending upon who the next president elected will be. I think we're in a very vibrant time for venture capital investing.
DP: Okay. So Alan, we have one of our EisnerAmper colleagues on the podcast. Please introduce him, if you could.
AW: Sure, Dave, thank you. I'm happy to welcome Michael Rosenberg. Michael is a director in the firm's PRTS practice and Michael is one of the firm's leaders in our practice dealing with the CFIUS rules, which are really the Committee on Foreign Investment in the United States. And I've asked Michael to talk a little bit this morning about what CFIUS means and also how it's impacting foreign investment here in the United States. So, Michael, maybe just a quick intro on CFIUS.
MR: Sure. Thank you, Alan. It's nice to be here as well. CFIUS is a governmental agency that is comprised and it's managed by the committee whose members are all on the cabinet. So you have the Secretary of Defense, Secretary of Treasury, Head of Homeland Security and so on. And their biggest concern is national security. And it's their job to review transactions in industries that have and could have an impact on U.S. national security. And from a venture capitalist standpoint, why do they need to be concerned about CFIUS? And it's that the real reason is that more portfolio companies, their portfolio companies need to consider whether they need to file with CFIUS or even do additional due diligence in the industries that maintain sensitive personal data, deal in critical real estate or critical technologies and infrastructure. And for those purposes, the information that CFIUS requires with the filings is so that they can determine whether or not they can actually allow this deal to go forward.
And in determining who needs to file, in the past, it had been based upon industry assessments and NAICS codes, to recently, as effective October 15th of this year, to an assessment based upon whether an export license would be required in order to export that critical technology. And the feeling with this is that it may result in more transactions being subject to mandatory filings with CFIUS. And what does that really mean? It can take time and it can take additional costs. CFIUS can take up to 45 days by statute to review the transaction. And the cost of that additional time could be significant to the transaction, to the parties involved.
AW: Michael, quick question. I think we all heard the debate last night, and we hear China, India, Russia mentioned continuously when we talk about foreign investment. Do you think that, depending on the outcome of the election, do you expect the CFIUS rules to become stricter, less strict? What do you think is going to happen?
MR: I think the rules are pretty strict right now and I don't see that changing. No matter which side of the aisle you speak to, they are all concerned about national security and they're concerned about maintaining the United States upfront. So, and that's really important. Right now, you have a lot of heightened sensitivity between China and the United States, and that has already had impacts. China investments in the United States with a covered transaction has declined to about 800 million this year to date, in the first six months of the year. And Japan has surpassed China as the leader in covered transactions coming into the United States. So their venture capital business has actually declined in China and increased from Japan because of the sensitivity with the investments. And these are strict.
DP:So Michael, not to pin you down on a specific candidate, but do you think the elections both for President and Congress will have a big impact on this?
MR: I don't believe it's going to have a big impact because I think the security around the United States, as I said, goes across both aisles. And I don't think that's going to change. I think there is there, no one wants the United States security to be lessened. We don't want to export critical technology that could give adversaries a leg up on us, and we don't want to impose problems on our own industries.
DP:Okay. So it's a better safe than sorry approach?
Dave Plaskow: Do you have anything else to add about CFIUS relative to VC investment, Michael?
MR: I think the one last thing that I would add is that CFIUS has an increased budget. It came about this year, and this has allowed them to review and expand their review capabilities. And that includes reviewing transactions that have happened in the past with firms that did not initially file. So if you're a company and you've sold an industry or purchased a company, if you're a foreign investor in the past several years, CFIUS has the authority to go back and review that transaction. And that cost can be significant, especially if they deem it impacts U.S. national security because they can cause the unwinding of that deal.
DP:Sounds like an interesting area, and one that I'm sure will grow, and we'll keep more of an eye on. Thanks for your expertise and your insight.
MR: Glad to participate.
DP:And thank you for listening to EisnerAmper's podcast series. Visit EisnerAmper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast, when we get down to business.