Dreaming Unicorns

There’s a problem in Silicon Valley. Maybe in the VC sphere at large. No one’s willing to admit it, but this problem is something that’s plaguing the industry that’s forcing founders to look for alternative financing vehicles.

Silicon Valley wants unicorns. And they won’t exit a project otherwise.

And it’s looking more like the region has its sights set on the legendary animal.

Early Stage Funding 2017

Early stage funding is what they call Series A and B funding. It’s often the funding round that most startups use to scale their core businesses, and monetize their service. When we talk about the VC industry at large, this is what most people imagine. Sequoia, Kleiner Perkins, among other big names — they’re all primarily involved in this stage.

Take a look at this chart, made by the good people at TechCrunch, with data from Crunchbase. It shows quarterly data for early stage deal number, and total volume over the past 5 quarters.

Let’s stop to do some simple math here,  before we move on. In order to calculate average deal size, we simply take the total volume, and divide it by the total number of deals. When we do this, we can see that the average deal size has gone up, especially when you consider year over year data for Q3. The average deal size in Q3 2016 was $7.64M, according to this data, while in 2017, it was $10.44M. That’s a jump of 37% in average deal size. Or, put simply, companies are raising a 37% larger round compared to the previous year.

This growth could be explained by many variables, but perhaps it could be best explained by the following chart:

Is this a bad thing? Probably not. It’s not like the dollar volume has decreased year over year. If anything, it’s shown a healthy growth. But, as seen in the table above, the market has shifted in its tendencies, to focus more on fewer companies, thus, forcing up average deal sizes. This might stress the liquidity situation of funds in the long run, as they have  more of their capital held up in fewer companies, leaving them little to no options in terms of exits. Or, it could play out in the complete opposite, with more liquidity, as promising startups become apparent early on, and become primed M&A targets. In fact, it could work to make the entire market safer for investors and LPs.

Late Stage Deals

Late stage deals usually mean stage C and later. It’s when a company is looking for capital for expanding outside its core business or market. Usually businesses take this funding in preparation for an exit. It’s by far the safest investment round for investors, but, as  a result, deliver the lowest returns.

Again, we see  a year over year increase in terms of funding volume. Interestingly enough, however, the average deal sizes here have trended downwards, ever so slightly, from $52.5M in Q3 2016, to $51.6M in Q3 2017. It’s a $900K difference, which is minute, and insignificant at this stage, but it’s a downwards trend, nonetheless.

The largest deals here also don’t seem to be as extreme as those done in the early stage. Albeit, we would need to know the valuations of these deals, but in terms of dollar values, they’re rather close. This conveys two things: first, companies at this stage are more profitable, and self sufficient, that they don’t look for external funding that dilutes their equity; and second, investors are looking for higher returns on their capital, pushing them away from the relatively safer option of late stage funding, to earlier stages.

Those two aren’t mutually exclusive. But it does imply an interesting situation. Investors now probably expect companies at this stage to be self sufficient, which equates to a quicker exit. By contrast, companies who haven’t turned a profit by this stage may find it extremely difficult to finance their operations by way of venture capital.

Now, what’s interesting is the TechCrunch article actually states Softbank as a major upwards force on the 2017 Q3 results. What I find to be strange is the downwards trend in average deal size if that’s the case. Softbank’s fund is $100B in size, which is second to none. Recently, they’ve finished talks with Uber, with Softbank looking to invest over $1B in the company. In fact, the smallest deal I’ve found, with Softbank’s involvement, is in Guardant Health, as part of a $360M round for the company.


Now this is where the story gets interesting, and worrisome. The only way VC assets and equities turn truly liquid is via an exit. Whether it be an M&A or an IPO, a startup has to find way of selling it self to turn liquid. In the US, M&As are the prevalent exit method, with IPOs being a distant second.

The above chart says $ raised. This is, actually, the acquisition value, or the valuation of the company at exit. In essence, the largest exit of last year was a $1.1B acquisition of Neotract by Teleflex. That pales in contrast to Cardioxyl Pharma’s exit of over $2B in 2015, or Stemcentrx’s exit at over $10B. Even as far back as 2012, Ancestry.com’s exit was valued at $1.6B.

Now these IPO numbers are a bit misleading. IPO sizes are determined by the number of shares put up for sales, multiplied by the price per share. In Roku’s case, the IPO price per share was $15.78. Working backwards from the current market cap, and stock price, we can see the market cap for Roku at time of their IPO was a bit over $1.5B. Doing the math for each company shows that Redfin was valued at $1.23B, Deciphera at $521.5M, Kala at $363.4M, Sienna at $308.1M, and Celcuity at $95.8M. Disappointing, yes, especially considering Fitbit, a company with a seemingly more niche market, had a market cap of $4.1B at IPO.

Seed and Angel

So what does this mean for the seed stage? Predictably, it means a bear market — both in terms of number of deals, and the overall market size.

Interestingly, however, the average deal size increased, showing an overall growing trend through the year. Variance, and uncertainty in the data is high, though, which implies the seed stage market is more volatile than ever.

This confirms a lot of what’s really happening on the ground, with more and more startups taking the accelerator route for kicking off their seed round financing efforts. The accelerator acts as a filter, of sorts, becoming the first screen that startups must pass through. It’s become a seal of quality, almost. Take YC, for example. It’s become the de facto seal of approval in Silicon Valley.

Unicorn Dream

That billion dollar valuation seems to be the tipping point in today’s venture capital industry. It’s the point, at which, ROI seems to accelerate out of control; the point at which money seems to print itself. So, it seems, everyone involved, is trying everything in their power to accelerate the process up to that point. So the vetting process, and the bandwagon effect, all have intensified over the past few years, at ever earlier stages.

There’s’ a simple conclusion to be drawn up here. As a founder, entrepreneur, dreamer, it’s now more difficult to get your foot in the door. But, once you do, the process is only going to get easier. And, as an investor, the hive mentality is going to have higher implications on the success of a project than ever before. In either case, you have to accept the fact that the hunt for the unicorn has fundamentally shifted the game away from investing in ideas, to investing in the consensus.



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