As startup valuations soared over the last five years, the sources of capital funding these companies changed. The type of investor who fueled the unicorns' rich valuations and mega-rounds included multibillion-dollar firms such as Tiger Global and Fidelity Investments. With abundant cash, capital costs near all-time lows and fewer attractive opportunities in the public market, mutual funds and hedge funds turned their attention to the private market. The thesis of these crossover investors was to capitalize on the high returns of presumably de-risked companies ahead of their IPO amid rising private valuations.
How has the crossover investment trend impacted the venture ecosystem? Based on our analysis of CB Insights' data, the top seven crossover investors alone participated in venture capital rounds totaling $42 billion in 2014 and 2015, with those rounds averaging more than $130M each year. (Private rounds above $100 million are also referred to as private IPOs). These investors have played a critical role in the emergence of unicorns, as roughly 40 percent of all crossover investments in 2014 and 2015 were made in companies valued above $1 billion.
Now, as public valuations are dropping and uncertainty is taking hold, crossover investors are reassessing their comfort level with both the type of company they invest in, and the associated investment structure. The current class of unicorns is different from late-stage investments of pre-boom years, when private companies typically only raised once visibility into exit opportunities was clear. Facebook, a forerunner to today's unicorns, raised a $1.5 billion mega-round led by Goldman Sachs in early 2011, and went public in June 2012. An 18-month period between the last private round and public offering is typical of technology IPOs, but crossover investors today may face a longer holding period. This elevates the risk of diminished returns for these illiquid holdings.
An uncertain exit horizon, coupled with the poor performance of recent technology IPOs, leads us to expect fewer deals and tighter terms coming from crossover investors in 2016.
Sources: CB Insights, New York Times, Pitchbook.com, S&P Capital IQ
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