Q&A: Silicon Valley Bank’s Aaron Gershenberg Puts Burn Rates and Valuations in Context

As seen in PitchBook, by Alex Lykken on January 7, 2015.

As part of our 2015 Annual U.S. Venture Industry Report, we reached out to Silicon Valley Bank's Aaron Gershenberg to ask him about his thoughts on the current VC industry, including his take on valuations and burn rates as well as his predictions for 2015. Keep an eye out for the PitchBook Newsletter next week, which will include a free copy of the report.

How do you see the first half of 2015 shaping up? Do you see any signs of a slowdown in financing activity? Or valuations, for that matter?

Going into 2015, barring a major macro-economic or geo-political event that would create a significant correction in the public markets, we believe the current demand for venture and venture-backed companies will continue to grow. We recently surveyed 80 General Partners from many of the best venture firms in the industry. Our survey asked them whether they believed there would be a major correction in private company valuations over the next 12 months. There was consensus that it would take a major, unexpected external event coupled with a corresponding public market correction to dramatically impact private company valuations. We see significant capital seeking exposure to the innovation economy, and demand is increasing. This is fueled by recent out-performance of private companies in the form of private financings as well as M&A and IPO exits.

There's been a lot of discussion about structural changes in the VC industry, with the rise of crowdsourcing, another boom in corporate VC investing and the traditional VC model bifurcating into mega- and micro-financiers. What is SVB's view on the changes in the industry, and what are the advantages SVB brings to the table?

Over the past several years, the venture capital industry has attracted an abundance of capital. This has resulted in a dramatic shift in power with successful entrepreneurs able to dictate financing terms in a way we have not seen before. In addition, we have seen many new investment models like crowdsourcing and corporate VCs as well as Accelerators, Super Angels, Public Investors and Limited Partners seeking co-investments. Of particular note, brand name venture firms are evolving and investing heavily in their service delivery teams such as marketing, design, recruiting and corporate partnering. We believe that the evolution of the VC industry is compelling and is responsive to the demands of today's entrepreneurs. SVB's unique advantage is its position as a trusted provider of financial services to the most successful entrepreneurs and investors. With no shortage of capital in the market, having a unique value proposition is critical to accessing the very best investment opportunities.

SVB released its Innovation Economy Outlook Survey results earlier in 2014 and found the most positive outlook among U.S. executives in the last five years. Can you give us a sense of the optimism you're hearing in the U.S. venture industry? Do you anticipate more optimism and momentum going into 2015?

Preliminary data for the 2015 Innovation Economy Outlook survey of entrepreneurs and managers indicates they are still highly positive about their future. Nearly all respondents indicated their outlook for business conditions in the year ahead is the same or better than in 2014. In addition, most are planning to hire additional employees. Anecdotally, we are finding that companies are optimistic and raising as much capital as they can; we do not see any signs of slowing. While venture capitalists have voiced caution around high valuations, the fear of missing out on great opportunities has kept their investment pace steady. We do not see optimism or momentum slowing in 2015 barring an unexpected major geo-political or macro-economic event.

We ran some numbers on approximate burn rates for U.S. software companies and found that burn rates have indeed gone up. As a firm that's heavily involved in startup financing, is this a concerning trend, in your opinion? And do you see any major differences between today and the dot-com bubble, the last time burn rates were this high?

High burn rates received a lot of public attention this fall. Compared to the dot-com bubble, today's companies are much better positioned to weather a market correction. We see real revenues and expanding margins addressing under-penetrated global markets. The most important developments are both mobile and adoption of the cloud, which are creating new market opportunities while reducing costs. While burn rates are high in some cases, most of those companies are quickly scaling to address massive markets. In addition, if required, many of those same companies can quickly move to break-even by rationalizing their business models.

On a related note, we found in our latest U.S. Venture Industry Report that 69% of third quarter financing were done at higher valuations than their previous rounds, versus just 18% in flat rounds and 13% in down rounds. Should the industry be concerned about this?

We do not believe the industry should be overly concerned about rising valuations for a number of reasons. The most important valuation is a company's value at exit along with an investor's ownership position. Recently we have seen more fund returners in our underlying fund portfolios than in the past. One reason valuations have been increasing is that traditional public market investors are looking to establish ownership positions before a company goes public. Once a high impact company goes public it is often too late for many public investors to achieve meaningful ownership positions relative to the size of portfolios they are managing. Corporate investors are also contributing to the upward pressure on valuations. They are more focused on the innovation economy than in the past in an attempt to stay ahead of disruptions to their business models. A third source of pressure on valuations is Institutional Limited Partners looking for co-investment opportunities. In an effort to drive down their costs of accessing the innovation economy, they look to invest directly into companies. Typically these investors are less valuation sensitive. To achieve compelling venture capital returns, investors still have to access breakout funds and breakout companies. It is a small fraction of the industry that drives all the returns. This concept of accessing the top decile performers in the industry has not changed and we do not expect it to change. Lastly, venture capital requires a long-term commitment by investors. It is critical to build into ones exposure and then maintain it over decades. Trying to time the industry is guaranteed to result in sub-optimal returns.

About the Author

Aaron Gershenberg is a co-founder and managing partner of SVB Capital. Aaron joined SVB in 1999. Over the last 20 years, he has created 10 fund of funds, five direct funds and five differentiated custom solutions as an extension of our limited partners’ teams. Aaron’s expertise is evaluating venture capital (VC) investments globally while building a unique value proposition for institutional investors seeking to access the innovation economy. He has published numerous articles on the future of VC and is frequently invited to speak and moderate panels at conferences in the US and overseas.

Before joining SVB, Aaron opened FirstCorp’s Northern California office, a VC leasing group focused on early-stage companies. In this capacity, Aaron was responsible for providing VC financing to more than 50 startup technology companies.

Aaron began combining his passion for cycling and philanthropy in 1984, cycling from Boston to Los Angeles, raising more than $200,000 for Oxfam America. He is a founder of the Hearst Castle Best Buddies ride, has raised more than $3 million for Best Buddies and serves on the international board.

Aaron has been an ambassador for the sport of kiteboarding since 2000. He has introduced numerous entrepreneurs and investors to the sport, creating a community around the globe.

Aaron graduated from Wesleyan University with a bachelor’s degree in economics and African studies and earned a master’s degree in finance and public policy from the John F. Kennedy School of Government at Harvard University. Aaron resides in Menlo Park, California.