The VC Unicorn Obsession Is Creating An Early-Stage Funding Wasteland
November 26, 2018
Founder and Principal
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In the past decade, we witnessed a complete transformation in the composition of the venture capital industry. A new asset class has emerged: unicorns.
Unicorns have completely transformed the VC landscape, tilting the funding scales toward a concentrated set of companies. A decade ago, unicorns represented a minuscule sector of the VC industry, with only six completed deals, which represented just 1.2% of total deal value for the year.
However, a substantial shift happened in 2014. In just one year, unicorn financing grew from $2.6 billion to $13.6 billion -- with more deals of this nature happening in 2014 than the previous three years combined.
Fast forward to 2018: the overall number of unicorn deals are stable at roughly 1.3% of the total number of deals closed. The truth of the matter is that unicorns continue to represent a very small share of the overall industry.
Yet, investors continue to pour money into creating these mega rounds. During the first nine months of 2018, unicorns attracted a staggering $19.2 billion in funding -- breaking 2016’s full-year record of $18.5 billion! In fact, the first nine months of 2018 have outpaced every full year on record in terms of deal value.
Essentially, 80 deals have attracted close to 25% of all VC funding for the year so far.
Let that sink in for a minute-- 1.2% of all VC deals has attracted close to 25% of all VC investments so far in 2018!
Over the last decade, unicorns' share in the industry skyrocketed from just 1.6% to 25% percent of the total amount invested.
With so much money chasing such a concentrated deal flow, reaching $500 billion, it’s no surprise that unicorn aggregate post-money valuations are growing rapidly.
Additionally, average unicorn deal values continue to hover at record levels, with 2018 posting a significant premium over 2017 levels and is on target to break the 2016 record.
It’s clear that valuations are sky rocketing because of the constant and massive inflow of capital into a highly-concentrated asset class. This asset class is increasingly dominated by mega funds, which is spearheaded by SoftBank’s mammoth $100 billion superfund. Many don’t realize that these mega funds are taking the place of an soft exit market, which is creating a vicious cycle of co-dependency, thus allowing unicorns to stay private longer.
With the total exits so far in 2018 clocking in around $80 billion, exit markets are trending at their five-year average, while number of deals closed should continue their downward trend since 2014.
Let’s assume for the sake of argument, that all exits going forward were unicorns (which is a stretch, since average exit stand at around $126 million), and that no new unicorns were created. It would take 7 years for the current exit market and around 13 years for the IPO market to digest the $500 billion USD aggregate unicorn post-money valuation. In reality, the time to digest those massive deals would be significantly longer, creating a worrisome liquidity problem and the need for mega funds to continue supporting later stages rounds.
While unicorns are hitting record activity, what is happening on the other side of the spectrum?
Both angel and seed round activity are on target for their lowest year since 2014, with substantial drops in the number of deals closed. If this trend continues in 2018, angel and seed activity will drop by 51% since peaking in 2015.
With dramatic drop in deal flow, VC first financing activity is also having a lackluster year, continuing a cycle that started back in 2014. First-time deal count is actually expected to fall in 2018.
If the industry continues on this path, the number of deals financed will be back to early decade levels. This means that the number of deals will be down by 40% since peaking in 2014, and the first financing market share of total VC funding will drop from 15.6% to 9%.
On the other hand, because of such significant deal concentration, average deal size has grown by 150% since 2013 from $5.1 to $12.8 million and is now at a 42% premium over the mean.
There are many ramifications of VC trending this way, but one trend stands out among the others. With an influx of new capital being deployed toward unicorns, early-stage companies are having a difficult time attracting funding. The "new Series A is the old Series B" adage is quite real.
In order for an investment to matter, VC funds are growing larger and need to invest substantial amounts per deal. This leads us to VCs pursuing a much more concentrated investment strategy.
Early-stage companies looking to attract capital need to be more mature and require strong milestones before investors are even willing to commit. The Valley of Death for startups has been tremendously elongated. This is creating the need for strong, early-stage players to bridge between early-stage round before the company is ready to attract VC funding. This concept is known as Venture Development.
The great divide for early-stage companies is very real. Unicorn chasing has created a new asset class as well as a self-fulfilling cycle, where a few massive deals suck the liquidity available for earlier stage companies. This ultimately leads to significant deal concentration and substantial deal value inflation, which is creating a wasteland in early-stage funding and increasing the need for Venture Development.
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