While Silicon Valley's technorati may be "living it up," new data from Pitchbok suggests the Venture Capital world is stuck in 'Hotel California' and "can never leave."
As Pitchbook.com's Katie Clark reports, opting to raise more funds rather than prioritizing an exit seems to be an increasingly popular route for startups.
According to data from the 2Q PitchBook-NVCA Venture Monitor, the number of US venture capital investments for every VC-backed exit reached a record high in the first half of 2017 – landing at 11.3x. For the 3,917 VC investments completed in 1H, there were just 348 exits.
If the trend continues in 2H, the US VC industry will experience the lowest exit levels since 2010. Similarly, but to a lesser extreme, investment count may end the year at the lowest mark in five years – 2012 was the last year the total number of financings in the US fell below 8,000.
Why is this happening? Companies are choosing to stay private longer as is evidenced by the data shown below: The average time to exit has hit roughly six years through 1H 2017. More specifically, median time to IPO now exceeds eight years, time to buyout is hovering around six-and-a-half years and time to acquisition has landed at about four-and-a-half years.
Both the number of US VC investments and the number of US-based exits have been on the decline since 2014. That year, capital exited reached a record high of $82 billion with more than 1,000 exits closed. Facebook’s $22 billion purchase of messaging platform WhatsApp certainly threw the numbers off a bit, but it was still a landmark year in many ways.
In the first half of this year, roughly $25 billion was returned to investors via 348 plus exits—about 30% of 2014’s totals and less than half of last year’s.
Perhaps this is why…
A recent paper by Will Gornall of the Sauder School of Business and Ilya A. Strebulaev of Stanford Business School, with the understated title Squaring Venture Capital Valuations with Reality, deflates the myth of the widely-touted tech “unicorn”. I’d always thought VCs were subconsciously telling investors these companies weren’t on the up and up via their campaign to brand high-fliers with valuations over $1 billion as “unicorns” when unicorns don’t exist in reality. But that was no deterrent to carnival barkers would often try to pass off horses and goats with carefully appended forehead ornaments as these storybook beasts. The Silicon Valley money men have indeed emulated them with valuation chicanery.
Gornall and Strebulaev obtained the needed valuation and financial structure information on 116 unicorns out of a universe of 200. So this is a sample big enough to make reasonable inferences, particularly given how dramatic the findings are.1 From the abstract:
Using data from legal filings, we show that the average highly-valued venture capital-backed company reports a valuation 49% above its fair value, with common shares overvalued by 59%. In our sample of unicorns – companies with reported valuation above $1 billion – almost one half (53 out of 116) lose their unicorn status when their valuation is recalculated and 13 companies are overvalued by more than 100%.
Another deadly finding is peculiarly relegated to the detailed exposition: “All unicorns are overvalued”:
The average (median) post-money value of the unicorns in the sample is $3.5 billion ($1.6 billion), while the corresponding average (median) fair value implied by the model is only $2.7 billion ($1.1 billion). This results in a 48% (36%) overvaluation for the average (median) unicorn. Common shares even more overvalued, with the average (median) overvaluation of 55% (37%).
How can there be such a yawning chasm between venture capitalist hype and proper valuation?
By virtue of the financiers’ love for complexity, plus the fact that these companies have been private for so long, they don’t have “equity” in the way the business press or lay investors think of it, as in common stock and maybe some preferred stock. They have oodles of classes of equity with all kinds of idiosyncratic rights.