Welcome to the era of mega-funds. Triggering a capital arms race never before seen, nontraditional investors are pushing private capital in the innovation economy to dizzying levels. Is this good for the venture ecosystem? It depends on where you operate in the innovation landscape.
We are beginning to see indications of how these super-sized funds, with capital sourced from across the globe, are impacting companies — from the seed and early stages to the late stage, and even public assets.
Private markets dominate led by SoftBank
Mega-rounds of $100 million+—aka PIPOs—have outpaced US tech IPOs in everyquarter over the past four years. Under the surface, the source of those private investments has changed dramatically. Mutual funds and hedge funds have scaled back their fervor since 2013–2015, and PE seemingly awaits more favorable valuations. Still, in 1H 2018, we saw 93 PIPOs—nearlymatching previous annual totals (see chart).
This is partly due to SoftBank’s insatiable appetite for innovative tech assets, which appears to only be growing. In 1H 2018, SoftBank led five $100 million+ rounds in the US. And in May, Masayoshi Son announced that he is planning a second mega-fund in the near future.
Even as more companies seek IPOs in 2018, it appears the PIPO will continue to dominate, allowing today’s best performers to stay private much longer than their predecessors. With this pattern established, how are investors reacting?
Extended horizons at the early stage
Venture firms are not ceding their territory. In fact, the immense global investor interest in innovation has allowed the upper echelon of venture capitalists to restock their war chests with significant capital to ensure continued participation, even as their portfolio companies raise multiple late-stage rounds.
Such abundant capital will result in upward pricing pressure across the ecosystem, impacting classic VC models. Elevated valuations make it harder for investors to obtain the returns expected from an alternative asset class. Indeed, the behemoths have created a bifurcated market, with the perceived “better” companies getting significant attention and the rest struggling to raise meaningful capital. This environment is leading some market observers to speculate that the “growth at all cost” mantra of 2014–2015 could return if top-tier companies accept bigger cash infusions than may be necessary.
Competition across the late stage
It’s likely competition for late-stage deals will intensify. The size and scale of these funds often limit their ability to invest in early-stage companies, which could drive even more capital to chase existing or near-unicorns.
The money is flowing from many sources: Venture-backed companies raised 2.5x the amount that their venture firm counterparts received in commitments in 2017. The threat of disruption and mounting piles of cash are driving corporate venture activity. Despite rate hikes, mutual fund and hedge fund managers continue to seek out growth. And now even sovereign wealth funds, some of which are doing direct investments, see the potential for extended time horizon.
Impact on the public markets
These mega-rounds often arrive at the stage when a company would consider an IPO to raise cash — but now they can delay it. Many of these mega-rounds provide secondary liquidity in addition to primary growth capital. The companies that are eyeing the public markets in most cases are more mature. But if the spigot of private cash turns off, public company asset managers should be prepared for an adverse impact on valuations across the spectrum.
In the long run, it is challenging for public investors when private markets capture the majority of company value. Between 2013 and 2015, we saw mutual funds aggressively cross-over for growth with mixed results and longer-than-anticipated holding periods. Perhaps this time we’ll see patience on the part of these investors.
We live in interesting times, and it is still unclear how significantly the mega-funds will impact traditional investment patterns. Investors who have been investing in disruption are finding themselves disrupted.