Upfront State of the VC & Tech Industry 2017

transcript

State of the VC Industry WTF Happened to Winter?

Some Upfront Views

Mark Suster, @msusterChang Xu, @_changxu

Things you already know

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

Valuations up 3x

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

…and we ushered in the age of

“the unicorn”*

Illustration by Goran Factory for Fortune

* Credit to Aileen Lee! :)

High prices, often with structure

Art by Freepik

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

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

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

Still great companies,

but valuation not

always what it seems

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

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

Made fewer investments Made more investments

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

And 76% of VCs reported valuations declined in 2016

Valuations decreased Valuations increased

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

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

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

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

Blame Global Warming. Seriously.

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

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

2009 2010 2011 2012 2013 2014 2015 2016

$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

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

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

led $800M Series C in(Feb 2016)

This is like 20 seed funds in just

one deal!

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

invested $690M in

(Mar & Oct 2016)

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

invested $50M in

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

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

PIF/ Mubadala

$100B tech fund (Oct 2016)

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

Kuwait

201520142013 2016

Saudi Arabia

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

allocated more capital to US deals

$350M AUM

invested $800M in

(Jan 2017)

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

More international LPs

No increase

28 Designed by Freepik

Global warming — Rise of the corporate VC

Increasing number of corporates have active venture investing arms

2012 2013 2014 2015 2016

131US Active CVC Investors By Quarter

Source: CBInsights

Of course there are the usual suspects…

Source: CBInsights

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

invested $200M in

(Oct 2016)

Active corporates continue to write large checks…

invested $500M in

(Jan 2016)

But large checks are coming from many sources now

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

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

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

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

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

Invest less in 2017 Invest more in 2017

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

Global warming — Exits supported by M&A

from non-traditional buyers

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

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

Biggest since

Most anticipated since

There is certainly a backlog of scaling companies looking for liquidity

Source: CB Insights

Global warming — VCs have significant dry powder

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

2012 2013 2014 2015 1H'2016

Contributions ($B) Distributions ($B)

Source: Cambridge Associates

Only 1H 2016

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

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

…and 300+ more!

Source: CBInsights

Microfunds are now a well-

established market, with many scaling

fund sizes

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%

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

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?

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

↑ + ↑ + ↑ + ↑ + ↑ + ↑

Unsurprisingly VCs are very bullish about 2017

Optimistic & bullish Innovations, but uncertainty Concerned

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

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

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

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

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

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

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

Anti-Trump Dislikes Trump Fine with Trump

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

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

Concerned Limited impact Optimistic

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?

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

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

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

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

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%

VCs are fundraising more quickly & we’re concerned

We’re fine with a faster pace

Cadence is normal

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

Want a healthy mix

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 :)

Thank you!

Mark Suster, @msusterChang Xu, @_changxu

Upfront State of the VC & Tech Industry 2017

Technology