sp q1 commentary2013

SHARESPOST Q1 COMMENTARY

MONITORING THE VENTURE CAPITAL MONEY FLOWEXIT ENVIRONMENT IMPROVES, TIPPING THE BALANCE

BACK IN INVESTORS’ FAVOR

SharesPost Financial Corporation, Member FINRA/SIPC

When attempting to gauge the health of the startup financing environment,

a key consideration is understanding the flow of institutional capital.

Specifically, how much capital is being put to work, how is that capital being

allocated, and how much cash return is being generated?

In this new quarterly report, SharesPost will monitor and analyze this flow of

cash. Our emphasis will be on longer-term trends, rather than the gyrations

and volatility characteristic of quarter-to-quarter data. Our goal is to remove

the ‘noise’ and focus on the most significant and long-term trends.

1©2013 SharesPost Financial Corporation. Member FINRA/SIPC.

Monitoring the Venture Capital Money Flow

LOOKING BEHIND THE QUARTERLY VOLATILITY OF THE IPO AND M&A MARKETS

Quarterly IPO market news and trends grab headlines, but often mask the underlying longer-term trends. This

is seen most dramatically in the chart below, which illustrates the cash raised by venture firms via IPO exits and

returned to their investors.

SOURCE: THOMSON REUTERS / SHARESPOST

Last year’s IPO of Facebook injected not only an element of drama into the IPO market as a whole, but also

suggested that IPO activity itself was staging an extraordinary rebound. Looking at the red line, the rolling

ten-quarter average, offers a better picture of what is actually taking place, and serves as a reminder that a

single transaction or even a single blockbuster quarter isn’t always a reliable indicator of a longer-term trend

taking shape.



That is why it is also useful to study the capital raised by IPOs excluding Facebook as shown below.


Here again, it is important to keep an eye on the red line, and what it says about the longer-term trend. From

one quarter to the next, one season to the next or one year to the next, IPO proceeds can be volatile. But in the

broader context, as we evaluate the rate at which venture funds are able to return capital to investors, it’s this

longer-term trend that is most significant – and specifically, the steady recovery from the depths of the 2010

trough that it represents.



But what happens in the IPO market isn’t the whole story. While IPO exits can generate half or more of total

proceeds in any given year, M&A exits are far more numerous and remain the most probable outcome for

most startup companies in venture capital portfolios. There too, as seen in the chart below, the trend has been

improving steadily since 2010, with the ten-quarter rolling average still trending higher despite the sharp decline

in recent M&A proceeds.


It’s important to factor in the context in which this M&A is taking place to understand this trend. Economists

agree that GDP growth is likely to remain lackluster for the foreseeable future, despite efforts by Federal Reserve

policymakers to trigger a more impressive recovery by keeping interest rates low. That creates a challenge for

corporate CEOs and other leaders: where will they find growth of their own, if not from growth in the economy?

One option is to use new technologies in order to operate more efficiently; another is to add new sources of

revenue. In either case, M&A provides a solution to the growth conundrum by offering these businesses a way to

acquire companies whose products or services can help them either cut costs or increase revenues.



THE FUNDRAISING FALLACY

A common source of angst and intermittent grumbling within the venture capital world is the perception that

startup funds are suffering acutely as the overall commitment levels by general partners to VC funds have fallen

over the years. In fact, what is happening is actually more subtle and far more interesting.

As seen in the chart below, the number of funds able to raise money successfully from venture capital limited

partners has fallen dramatically from its peak during the dotcom heyday. But as the rolling ten-quarter average

shows, that has leveled off in recent years.

Of course, in any given quarter or year there may be a sharp increase or decrease if a large venture firm sets out

to raise its next mega-fund. But the longer-term trend now is stable to slightly positive.

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Quarterly VC Fundraising [# of firms]

All VC Funds First Time Firms 10 Quarter Average All Funds 10 Quarter Average First Timer Firms




What also is intriguing is the fact that the frequently voiced anxiety about the outlook for first-time funds – newly

created venture capital partnerships raising their first round of capital – appears unfounded. A quick glance at the

bottom of the chart, which tracks the rate at which first-time funds have been financed, shows that this has been

climbing steadily, if not spectacularly, since 2003.

However, what might help explain the mutterings of discontent is the fact that the average number of dollars that

limited partners are willing to allocate to first-time funds, as a group, has remained little changed, as seen in the

chart below.

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Quarterly VC fundraising [$MM]

First Time Funds raised Total VC Funds raised 10 quarter average VC fundraising 10 quarters average First Time fundraise


Investors have put an average of $500 million into first-time funds each quarter over the course of the last 7

years. These days, however, given the increase in the number of those funds receiving financing, that capital is

spread more thinly across the entire universe.



Indeed, what we are witnessing is a bifurcation of sorts taking shape in venture financing, with limited partners

putting a certain – but finite – amount of capital into these new venture funds, even as they direct a growing

sum, in absolute terms, to the largest funds being raised by venture partnerships with a blue-chip reputation and

a long track record. This ‘barbell’ approach mirrors one used in the public equity market, when investors place a

relatively small amount of capital into higher risk/higher reward securities while offsetting that by investing heavily

in the well-established companies at the other end of the risk spectrum.

THE BOTTOM LINE…

It has been a long, hard climb out of the trough for both venture capital partnerships and their investors, but at last

the flow of funds has tipped firmly back in the favor of the latter. After more than five years during which limited

partners put more money to work financing startup companies than they received in exit proceeds, the balance

shifted in 2011. Since, then, as the chart below illustrates, the picture has become steadily more favorable.

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Funds Raised Vs. Es.mated VC Share on Exit Proceeds

10 Quarter Average VC shares of M&A proceeds 10 Quarter Average VC shares of IPOs FB Impact on IPO Average 10 Quarter Average VC Fundraising




This has resulted in what appears to be a normalization of the venture capital market. On one hand, investors

have become more disciplined in the level of funding to this asset class, while the recovering M&A and IPO

markets have stabilized the return part of the equation.

This is an encouraging signal; capital flowing back to investors in the shape of distributions from venture capital

funds can only increase confidence in the asset class as a whole.

The IRR may still look dreadful because of the prolonged period of subpar returns that followed the dotcom

collapse. Still, this new and emerging net positive flow of funds offers the possibility that younger venture funds

may be on track to deliver healthier IRRs to investors in the future.

READ THESE IMPORTANT LEGAL NOTICES AND DISCLOSURES

NONE OF THE INFORMATION DISPLAYED IS A PUBLIC OFFER TO BUY OR SELL ANY SECURITIES. SHARESPOST PROVIDES A FORUM FOR THE INTERACTION OF SELLERS OF SECURITIES TO INTERACT WITH BUYERS WHO HAVE BEEN QUALIFIED AS ACCREDITED INVESTORS PURSUANT TO U.S. SECURITIES LAWS AND REGULATIONS BY SHARESPOST FINANCIAL CORPORATION, MEMBER FINRA AND SIPC.

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