tl;dr: VC is getting back to normal. Here’s who that helps, and here’s who it hurts.
Since late last year, many tech industry investors and insiders loudly forecast that in 2016 the “tech bubble” would implode. They claimed that pre-IPO “unicorns” and publicly-traded tech companies were significantly over-valued, the tech bubble would burst, and funding would dry up.
So far this year we’ve seen some air leak out of the balloon, but it hasn’t popped, and I don’t think it will.
Instead, we have seen a rational recalibration of risk, a reversion to the mean, or a restoration of balance between fear and greed. In general, investors are more cautious, but the effects are not evenly distributed. It is clear there has been a flight to perceived safety and quality. It’s safe to say now that investors are all from Missouri, the “Show Me” state.
Over the past 12 months, Silicon Valley has suffered its share of disappointments and painful adjustments after quarters of continued increases. No matter where you looked, tech valuations were extremely volatile in the first half of this year—both in public markets and private. After two quarters of declines, private company financing activity rose slightly in the second quarter, but this increase was driven largely by big financing rounds for a handful of top “Unicorns.” Overall, the number of deals continued to decline, especially at the seed stage.
I recently sat down with Mattermark’s Alex Wilhelm to discuss first half tech investing trends, and what we expect as we head toward 2017. Here’s what I see happening.
Unicorn Safe Havens (For Some)
Later stage VCs focused on investments in leading Unicorns with established track records over the past few years. These VCs are hoping for modest returns and relative safety, specifically big names like Uber and Snapchat.
Over the same period, the late stage public market investors that also bought into pre-IPO companies retreated from the market. Firms like Fidelity and Wellington, which are typically active in the IPO market, began to aggressively snap up shares of pre-IPO companies as demand outpaced supply and the market heated up over the past two years.
But this “fear-of-missing out” largely dissipated in Q1 and Q2, and despite the public markets hitting new highs, I expect this class of investor to remain cautious. As a result, some lesser Unicorns will struggle to attract financing and face lower valuations or tougher terms and some of them will disappear.
Where Angels Fear To Tread
The pace of investment by angel and seed investors slowed significantly in the first half of 2016.
According to Deloitte, the number of U.S. early stage investments fell to 990 in Q2, the fourth straight quarterly decline. The pain was not shared equally, however, as total dollar value of these deals rebounded slightly from Q1 to about $2 billion.
This suggests there is cash available, but angels are being much more selective. This is not surprising; individual angel investors make decisions with their own money over a shorter time frame and are thus much more sensitive to market turmoil.
I expect a similar degree of caution going forward.
Angels are often seen as an easier source of cash, but they are immune to the institutional pressure of LPs expecting funds to be deployed in a specific timeframe. Therefore, angels are more likely to remain on the sidelines and wait for calmer conditions.
Strategic Investments on the Up and Up
“Adapt, Adopt, or Adios.”
Strategic investors increasingly realize they must invest in startups to stay abreast of and counter disruptive technologies that could make them obsolete. Their mantra (should be): “Adapt, Adopt, or Adios.”
Investors need to avoid being leapfrogged and they need to add new revenue streams to their existing product lines that depreciate over time. That’s why we saw a number of these deals in the first half of the year, such as Volkswagen’s $300 million investment in cab-hailing service Gett, and Comcast Venture’s financing of fintech startup Bento for Business.
Some Fortune 500 companies have invested directly in VC funds such as ours with an explicit mandate to vet new technologies of relevance for them on a regular basis; others have launched their own investment vehicles. VCs can serve as “filters” for innovation. At Blumberg Capital, we meet with corporate delegations on a regular basis to help our portfolio companies find customers, distribution partners, investors and sometimes acquirers.
This is a very positive trend for startups, and one that is likely to continue for the foreseeable future, despite macro-economic ups and downs. Technology innovation is too important to stop investing – even during market retrenchments.
Net, Net, Bad News, Good News
While the U.S. isn’t in a recession, the bad news is that we, and most OECD economies, are mired in dangerously slow growth. I think much of this is self-inflicted due to poor governmental policy choices, but that is a subject for another day.
Sure, valuations have come down, markets are volatile, and investors remain cautious. But these conditions represent a rational repricing of risk. And let’s face it, the repricing was overdue and this uncertainty is likely to persist for the next several quarters. Downward adjustment is never fun, but a return to more rational valuations is good for the industry, aligns the interests of entrepreneurs and investors, and reestablishes a solid foundation upon which to move forward.
Market cycles come and go, but there are still a lot of innovations to create, products to build, entrepreneurial teams to support, and value to be created. Let’s get back to work!