The Incredible Shrinking Seed Stage and Other Venture Trends of 2014
By now the 2014 data for venture capital investments from the most important regions of the world have been compiled and disseminated. When laid out next to each other, some fascinating themes emerge.
It’s no surprise that the U.S. continues to set the pace with over $48 billion invested in 4,356 companies, compared to 2013, when nearly $30 billion went into in 4,193 companies, according the National Venture Capital Association’s MoneyTree Report. Overall, the average size per deal increased from $7.1 million to $11.1 million in 2014.
But when one looks closer, the rotation from seed and early stage deals to expansion stage investments was quite dramatic—41 percent of all capital invested in 2014 was in expansion stage companies, as compared to 33 percent in 2013. The average round size of expansion stage investments spiked to $17 million from $9.5 million in 2013.
This underscores a significant development in the venture capital market—companies are raising larger later stage rounds and staying private longer.
Arguably, venture investors are generating greater overall returns by encouraging portfolio companies to stay private longer. In 1986 Microsoft went public at a $500 million valuation and traded to over $3 billion within the first year (and then increased 30-fold over the next 8 years). Google went public in 2004 at a roughly $25 billion valuation and traded to over $80 billion after its first year. Facebook went public in 2012 at a $100 billion valuation and, after some hits to its stock price, recovered its IPO valuation nearly 15 months later. And of course, Alibaba went public at a $225 billion valuation and now trades slightly lower, with a market cap of about $210 billion. These are only a few of the most notable success stories, but they demonstrate a company’s ability today to raise very large private rounds of capital to fund hyper-growth, affording early stage investors much more of the upside.
Against this backdrop, though, there is an explosion in the number of early stage companies being formed, and many of them are not raising traditional venture capital.
In 2014, over $718 million was invested in 192 seed stage companies by venture firms. That compares with more than $1 billion that VCs invested in 235 seed stage companies in 2013. Crunchbase had over 25,000 companies in its database in 2008; today that number is converging on 700,000, and a very small percentage of them raised capital from VCs. With fewer active venture capital firms nowadays, one might argue that the VC industry may not be well-positioned to provide seed capital. Maybe VCs are not able to compete as effectively against other sources of capital, such as incubators and super angels? Or maybe VCs are simply being more discerning, given the lack of differentiation between so many look-alike startups?
Shikhar Ghosh, a Harvard Business School senior lecturer, recently studied 13,500 venture-backed companies to see how many failed to return 100 percent of their capital to first-round investors, and the results are disturbing.
Since 1990, 76 percent of the companies in this study failed to return 1x to first-round investors (82 percent in the 1996-2000 vintage were particularly guilty of that). Even more troublesome (although perhaps not that surprising), in cases when the founder was fired, 90 percent of the companies failed to return all the capital invested by first-round investors. According to Pitchbook, 40 percent of all VC-backed exits in 2014 amounted to more than $100 million, which means one of two things (or both): Most of those returns went to later stage investors, or the capital loss rates for the other 60 percent of those exits in 2014 must be very high. In other words, many of those companies sold for much less than invested capital.
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