Venture Capitals Tread Cautiously Due to High Valuations

DP: So Alan, a lot has happened so far in 2018. Why don’t you give our listeners some highlights from quarter one and quarter two of the VC market.
AW: You know, I think if you follow the VC market, you have to be bullish. We’re certainly can seeing a continuation of an extremely active market. You know, for example, almost $58 billion was - of venture capital money - was invested in the first two quarters of ’18 in U.S. companies, which was actually higher than six out of the past ten full year totals.
DP:Ok.
AW:Just an amazing number.
DP:Yeah.
AW:You know, 2018 actually will be the first year that over $100 billion of venture capital was invested in the U.S….
DP:Wow
AW:… since probably the late 1990’s. VC companies continue to raise larger and larger pools of capital and they’re staying private longer as a result of the ability to raise these larger amounts of capital. You’re seeing, you know, dry powder at historically high levels, so larger financing rounds are becoming… becoming more of the norm. You’re seeing the IPO market starting to come around a little bit. So far in 2018 there have been eleven unicorn companies that have seen exits through an IPO – total deal values almost $30 billion. In addition to the larger deals, you know, the angel and seed deal market remains fairly robust. You know, the median angel investment in the first half of the year was $830,000. The median seed deal investment was almost $2.1 million. Valuations were up. Valuations in the first half of ‘18 were almost $7 million for seed and angel deals, which is almost $1 million higher than 2017. So, it’s a really robust and frothy market.
DP: Ok. Now, you were telling me earlier about a lot of activity in artificial intelligence and fintech. Tell us a little bit more about those.
AW: You know I think, you know, VC… the nature of the venture capital business is that VC’s have to constantly be investing in what they think are the most interesting new technologies…
DP:Sure
AW:…hoping to provide the highest returns for limited partners. And I think if you look at, you know, interesting and fast growth technologies today, you’d be remiss if you didn’t include artificial intelligence and FinTech. For example, in Q2 alone, AI and FinTech companies raised about $5.3 billion alone – pretty large number.
DP: Yeah, yeah, so something to keep an eye on. Talk to me a little bit about deal size and scope.
AW: You know, as I said earlier, there’s an awful lot of dry powder on the sidelines waiting to be invested. You know, VC’s have raised enormous funds over the last three to four years so, I’ve seen estimates upwards of $140, $150 billion of dry powder waiting to be invested. So as a result of that money needing to find a home, you’re seeing, you know, a tremendous amount of capital being invested and you’re seeing robust activity at all… all sizes of the market. You know, larger funding rounds are certainly in vogue. So you’re seeing a lot more larger deals than smaller deals. And as I said earlier, you know, there… companies are staying private longer, you’re seeing the M&A… the M&A market for VC backed companies is still relatively slow because companies can continue to raise capital. It’s a good, good market for raising capital.
DP:Sure. As far as economic indicators go, we’ve seen some really positive things - employment rates, stock market – and we’ve seen some things that are, you know, giving us a little bit of trepidation as far as the tariffs. How does that all play into the VC market?
AW:I think the biggest concern that VC’s have today is the issue of valuation. You know valuations are, you know… you know some people say they’re getting out of hand a little bit.
DP:Well, and by the way, we’re discussing this on the day after Apple hit $1 trillion.
AW:Exactly right, you know, great example. You know, Apple had some great news, can Apple continue to innovate…
DP:Right.
AW:…in the future and keep that stock price up, you know, who knows.
DP:Yeah.
AW:But I think, you know, it’s almost like the perfect storm. You have venture capitalists that are sitting on, you know, large amounts of capital, they have to invest it, their LP’s aren’t paying them management fees to invest in, you know U.S. treasuries, prices are really high, and I think a lot of, you know, VC’s are moving, you know, very gingerly, you know, in terms of making investments because of those high values. How much higher can it go?
DP: Sure.
AW: That’s really the question today.
DP: So what’s the liquidity path du jour?
AW: Interesting question. You know VC’s are certainly holding companies longer. Valuations continue to rise. I think we’re certainly beginning to see encouraging signs for the IPO market finally. You know the Q2 of ’18 was the fifth consecutive quarter with more than ten venture backed exits. So the market is coming around nicely. You’re still not seeing a vibrant M&A market for venture backed companies. You know, they’re not being sold to large, you know, private companies. You are seeing, you know, interestingly a lot of VC backed companies are being sold to private equity groups…
DP: Ok.
AW:…which is something we haven’t seen in a long time. So I would expect that the M&A market for VC backed companies should be coming more active in the next I’m going to say six to twelve months.
DP:Yeah, and that leads me to my next question. What are you looking at for the second half of 2018?
AW: I think you’re going to see a lot more of what happened in the first half. I think you’re going to continue to see a robust market, a lot of capital being invested, a lot of larger deals being announced. If I was a betting person I would bet that 2018 will be $100 billion investment market for VC companies.
DP:Ok. Sounds good. Well, thanks for your expertise and your insight, as always.
AW:Thanks Dave.
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.