State of the VC Industry WTF Happened to Winter?

Some Upfront Views

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Mark Suster, @msusterChang Xu, @_changxu

Things you already know

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In 2013-2015, the VC market overheated, driving irrational behavior

Valuations up 3x

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Capital invested up 2x

$6.2B to $16.7B

A) Median pre-money valuation for VC-backed tech startups rose from $17M in 1Q’13 to $68M in 3Q’15, where 4Q’15 dropped to $28M, Dow Jones VentureSource Venture Capital Report 4Q’15 B) Total dollars raised by startups from 1Q’13-3Q’15 grew from $6.2B to $16.7B, where 4Q’15 dropped to $12.3B, PWC National MoneyTree Report 3Q’16

$17M to $68M

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…and we ushered in the age of

“the unicorn”*

Illustration by Goran Factory for Fortune

* Credit to Aileen Lee! :)

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High prices, often with structure

Art by Freepik

VC: “You name the price, I name the terms.”

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IPO downside protection Participating preferred

$3.6B valuation

Note: most recent financing in Aug 2015 (Series F); IPO protection on Series A, B, D, E, F, with threshold at $15.78 per share and aggregate proceeds of $100M Source: Pitchbook VC Unicorn Report 2016, Pitchbook

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IPO downside protection Multiple liquidation preferences

Participating preferred

$1.7B valuation

Note: IPO protection on Series C (2014) and Series D (2015), with threshold at $33.82 and aggregate proceeds of $70M and $100M respectively. Series B (2013) has 2x liquidation preference, Series C has 1.43x Source: Pitchbook VC Unicorn Report 2016, Pitchbook, The Information

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Still great companies,

but valuation not

always what it seems

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Many predicted that winter was coming. WTF happened to winter?

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Twice as many VCs did cut investment pace in 2016.Winter was real

Made fewer investments Made more investments

16%

31%

Q. What was your deal activity like in 2016 vs. 2015? Excluding follow ons. Excluded 53% of respondents that answered “about the same pace” Source: Upfront Ventures survey of VCs (N=114), Jan 2017

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And 76% of VCs reported valuations declined in 2016

Valuations decreased Valuations increased

8%

76%

Q. Would you say valuations in 2016 were higher, lower or remained about the same vs. 2015? Excluded 16% of respondents that answered “about the same.” Source: Upfront Ventures survey of VCs (N=114), Jan 2017

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2016 was the year our industry took cost-cutting seriously and most say this work is behind them

25%

12%

63%

Q. Which statement best describes the spending behavior at most of the more mature companies in which you are on the board or observe (i.e. not super early stage)? Source: Upfront Ventures survey of VCs (N=114), Jan 2017

Cut costs in 2016

Planning to cut costs in 2017

No changeJust 12% cutting in

2017

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So, yeah. Winter DID come. But it sure was mild!

Blame Global Warming. Seriously.

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“Global” warming—part 1: China, Japan, Asia more broadly

“Global” warming — Influx of foreign capital into US startups

1

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2009 2010 2011 2012 2013 2014 2015 2016

$29B

$10B$9B$12B

$7B$4B$4B$1B

Note: Includes all FDI in all states and industries excluding real estate Source: Rhodium Group China Investment Monitor

Chinese Foreign Direct Investment (FDI) has poured into the US. Tech sector has clearly benefitted

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The US has FANG, China has BAT: Baidu, Alibaba & Tencent. All very aggressive in US investments.

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Baidu launched two major funds in 2016 — increasing investment pace to match its peers

Baidu Venture Early-stage fund AI, AR / VR, next-gen tech

Baidu Capital Late-stage tech fund $50-100M checks

$200M

$3B

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led $800M Series C in(Feb 2016)

This is like 20 seed funds in just

one deal!

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But there are a huge number of other Chinese funds now moving into venture that you’ve never heard of with a mandate to bring innovation back to China

Government-backed funds Cross-Border Funds

Private Corporations

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invested $690M in

(Mar & Oct 2016)

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led $80M Series B in

(Aug 2016)Note: Other investors include CMC Holdings (China), Founder H Fund (China), China Assets Holdings (Hong Kong), SoftBank Group (Japan), and several US-based investors

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invested $50M in

(Jun 2016)Note: US-based Comcast Ventures, Draper Associates, Presence Capital also participated but did not lead the round

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Of course it’s not just China: SoftBank / Saudi Arabia’s

PIF/ Mubadala

$100B tech fund (Oct 2016)

&

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As oil prices have collapsed, the Arab states have been eager to diversify their assets

$165M

Kuwait

201520142013 2016

$3.5B

Saudi Arabia

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Temasek (Singapore’s soverign wealth fund) opened a US venture office &

allocated more capital to US deals

$350M AUM

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invested $800M in

(Jan 2017)

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93% of VCs have seen an increase in interest from an international LP base*

Q. In the last fund you raised, did you see increased interest from international sources of capital to invest as LPs in your fund? *Excluded those that answered “Didn’t reach out, so don’t know” Source: Upfront Ventures survey of VCs (N=114), Jan 2017

93%

7%

More international LPs

No increase

28 Designed by Freepik

Global warming — Rise of the corporate VC

2

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Increasing number of corporates have active venture investing arms

2012 2013 2014 2015 2016

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131US Active CVC Investors By Quarter

Source: CBInsights

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Of course there are the usual suspects…

Source: CBInsights

80-90 deals/year 70-90 50-70 30-50 20-30

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invested $200M in

(Oct 2016)

Active corporates continue to write large checks…

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invested $500M in

(Jan 2016)

But large checks are coming from many sources now

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ramps up venture fund to $530M (Nov 2016)

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When Sesame Street became a venture investor, you know the market has moved

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Unlike VCs, in 2016 twice as many Corporates made more investments than cut back. They filled in the gap

Made fewer investments Made more investments

34%

18%

Q. What was your deal activity like in 2016 vs. 2015? Excluding follow ons. Source: Upfront Ventures + CBInsights survey of CVCs (N=40), Jan 2017

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And half of Corporate investors expect to do even more in 2017

Invest less in 2017 Invest more in 2017

50%

Q. Would you say valuations in 2016 were higher, lower or remained about the same vs. 2015? Source: Upfront Ventures + CBInsights survey of CVCs (N=40), Jan 2017

3%

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Global warming — Exits supported by M&A

from non-traditional buyers

3

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acquired for $5.8B

acquired for $3.3B

acquired for $1.2B

for $3.5Bacquired

for $1.4Bacquired

New, traditionally non-tech buyers entered the M&A market, seeking innovation and technology

…Source: Dow Jones VentureSource

acquired for $1.4B

acquired for $1.0B

is acquiring for $3.7B

39 Source: Aberdeen Assets

Middle-market PE also entered, seeking growth

acquired

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All eyes on the Snapchat IPO as a potential signal for 2017 IPO markets

Biggest since

Most anticipated since

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There is certainly a backlog of scaling companies looking for liquidity

Source: CB Insights

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Global warming — VCs have significant dry powder

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LPs have finally restocked coffers with distributions (plus many new LPs getting into the game)

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2012 2013 2014 2015 1H'2016

8

2832

2223

6

1517

1315

Contributions ($B) Distributions ($B)

Source: Cambridge Associates

Only 1H 2016

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2009 2010 2011 2012 2013 2014 2015 2016

# of funds closed Capital raised ($B)

423535

2124232012

253255268

204190

141153

122122

153141

190204

268255 253

Source: Pitchbook/NVCA Venture Monitor 4Q’16

More LP money = more funds, more dollars = warmer winter

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2016 saw many megafunds raised

$1B$1B$1.1B$1.2B$1.2B$1.2B$1.3B$1.6B$2B

$2.5B$3.2B

11 firms raised $1B+ 12 firms raised $500M+

Source: DowJones Venture Source 1Q’16, 2Q’16, 3Q’16; Pitchbook data; represented aggregate sums over funds raised that invest in US tech ecosystem by each VC

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…and 300+ more!

Source: CBInsights

Microfunds are now a well-

established market, with many scaling

fund sizes

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Low interest rate environment encourages more capital to chase venture capital yields (cited by 77% of LPs as large driver of VC industry increases)

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Q: In 2016 many investors warned “Winter is Coming” referring to a slowdown in venture markets. That slowdown happened but was very short lived. Which of the following are relevant? Source: Upfront Ventures survey of LPs (N=78), Jan 2017; Federal Reserve

Federal Funds Rate, 2007 to 20165.25%

.25%.75%

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Trump’s proposed tax holiday, if passed, will lead to repatriation of capital, which will in turn fuel more M&A and investments

$49B

$52B

$62B

$113B

$230B

Note: Cash figures include cash, cash equivalents and liquid marketable securities held offshore Source: Moody’s Investor Service, as of end of 2016

Top 5 Companies by Offshore Cash

Top 5 alone have $500+ billion in offshore cash

So where are we heading?

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Foreign capital

Corporate investors

Increased LP distributions

New VC funds, bigger funds

Repatriation of capital

Likely robust M&A and IPO markets

Good prognosis for venture andtech market funding in 2017-18

↑ + ↑ + ↑ + ↑ + ↑ + ↑

=

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Unsurprisingly VCs are very bullish about 2017

Optimistic & bullish Innovations, but uncertainty Concerned

11%

28%

61%

Q. Which of the following statements best describes your personal mood heading into 2017? Source: Upfront Ventures survey of VCs (N=114), Jan 2017

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The current category VCs are most interested in funding is AI / Machine Learning

85% rates it more interesting than other areas

AI / ML

AR / VR

IoT

Blockchain

Bots-based commerce

58% rates it the most important area in next 5-10 years

Q. How do you feel about the following investment areas? Source: Upfront Ventures survey of VCs (N=114), Jan 2017

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Of the major emerging venture categories, VCs are most skeptical about bots-based commerce and blockchain

53% thinks it’s too hyped

Bots-based commerce

Blockchain

AR / VR

IoT

AI / ML

13% is deeply skeptical

Q. How do you feel about the following investment areas? Source: Upfront Ventures survey of VCs (N=114), Jan 2017

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Regarding Trump, the venture community is concerned on a number of point issues

63% some impact 25% very naive

Surveillance & cyber security

Employment & social policies

72% some impact 18% deeply worried

Q: Do you believe a Trump Presidency could have an impact on ___? Source: Upfront Ventures survey of VCs (N=114), Corporate VCs (N=40), and LPs (N=78), Jan 2017; CBInsights assisted with CVC survey

57% worried 20% very concerned

Immigration

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Overwhelmingly our industry (83%) is very anti-Trump or dislikes him as a president

Anti-Trump Dislikes Trump Fine with Trump

66%

17% 17%

Q: How do you personally feel about a Trump presidency? Source: Upfront Ventures survey of VCs (N=114), Corporate VCs (N=40), and LPs (N=78), Jan 2017; CBInsights assisted with CVC survey

but he’s irrelevant

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But most people don’t believe a Trump presidency will have much impact on the venture capital industry

Concerned Limited impact Optimistic

25%

70%

5%

Q: Considering all these issues (offshore development, H1-B, M&A, surveillance, China relations / manufacturing, etc.) how will a Trump presidency impact venture capital? Source: Upfront Ventures survey of VCs (N=114), Corporate VCs (N=40), and LPs (N=78), Jan 2017; CBInsights assisted with CVC survey

Although maybe this has deepened since inauguration?

How do LPs feel about the direction of our industry?

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The good news is that 3x as many LPs are trying to grow their allocation to the venture asset class vs. feeling over-allocated

Trying to grow VC allocation Over-allocated to VC

11%

32%

Q. How would you describe your fund’s current allocation to VC? Source: Upfront Ventures survey of LPs (N=78), Jan 2017

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And for newer funds LPs are actively looking to add managers to their roster

Looking to add Cutting back, may add 1-2 Too many

2%12%

45%

Q. How would you describe your fund’s current outlook on VC managers? Source: Upfront Ventures survey of LPs (N=78), Jan 2017

VC managers VC managers

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Overwhelmingly LPs are concerned about the cadence of VC investments and frequency of fundraising (Some funds now on 2-2.5 year cycles)

Q. How would you describe your fund’s outlook on your existing (VC) managers funding (and fundraising) pace? Source: Upfront Ventures survey of LPs (N=78), Jan 2017

23%11%

66%

VCs are fundraising more quickly & we’re concerned

We’re fine with a faster pace

Cadence is normal

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LPs want a healthy mix across all stages of venture.A large number said they felt Series A/B was their best fit and majority are concerned about growth-stage valuations

Q. How would you describe your fund’s outlook on the seed market / traditional Series A/B venture capital / later stage venture capital & growth equity? Source: Upfront Ventures survey of LPs (N=78), Jan 2017

Seed Series A/B Growth

Over-valued 60%

Over-done 18% Being squeezed 14%

Bullish 7%

Best fit 30%

Invest but discerning

75%

Want a healthy mix

57%

Want a healthy mix

38%

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What does this all mean?

Global is likely here to stay — despite the efforts of the Trump Administration

Warming is the forecast for funding the next 2 years

Returns are ultimately what matter.Over-funding creates new & different challenges.

I suspect we’ll debate over-funding in 2018-2022 :)

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Thank you!

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Mark Suster, @msusterChang Xu, @_changxu