CBInsights has published its annual survey on corporate venture capital (CVC). Globally, 2,740 deals were completed raising $52.95 billion. This represented an increase of 32% in number of deals over 2017 and an increase of 47% in total capital raised over the preceding year. The average CVC deal size has reached an all-time high of $26.3 million. CVC investors participated in 23% of all venture backed deals completed in 2018. The number of new active CVC firms has increased with new entrants in 2018 including Coinbase Ventures, Maersk Growth, and Porsche Venture. Direct investments from corporates also reached an all-time high of 3,820 deals in 2018, which represents a 33% increase in the number of deals compared to the prior year. Of the CVC investors, Google Ventures was the most active with investments in 70 companies in 2018. Salesforce Ventures and Intel Capital followed Google Ventures as second and third most active, respectively. By sector, CVC investments in Internet startups and healthcare companies increased significantly. While deal activity also increased in Asia, the most noteworthy increase came in the United States with 1,046 deals completed in 2018.
In a recent paper titled, “Public or Private Venture Capital?” author Darren M. Ibrahim compares the relative benefits associated with reliance on private capital to fund start-ups and emerging companies with “public” venture capital in the form of securities exchanges like the London Alternative Investment Market, or AIM. The author looks at three such venture exchanges, the AIM, the German Neuer Markt, or NM, and Hong King’s Growth Enterprise Market, or GEM. The author did not use the Toronto Venture Stock Exchange because most of the listed companies are not technology-based companies. None of the three exchanges examined has proven as successful an approach to funding emerging companies as has the US venture capital model. The paper notes that in connection with investing in earlier stage companies, there are information asymmetry issues as well as agency costs. The author notes that, in part, the failures of each such exchange may be attributed to the manner in which these exchanges addressed information asymmetries and agency issues. In the case of the exchanges, corporate and securities law requirements were relied upon. In the US venture model, VCs rely on private contractual arrangements and staged financings to reduce asymmetries. Over time, the US venture model has proven to be more effective in funding successful growth companies. Proponents of capital markets reforms regularly recommend that US policymakers consider venture exchanges despite the lack of success of venture exchanges outside the United States. See full report here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3266756
In “Squaring Venture Capital Valuations with Reality,” authors Will Gornall and Ilya Strebulaev developed a valuation model for venture capital-backed companies that relies on terms of financing rounds that were gleaned from public filings. Using these reported valuations, the authors then calculate values for all share classes for each of the 135 US unicorns in the study sample set. In doing so, the valuation of shares of common stock is adjusted down to reflect the fact that reported valuations relate to preferred stock and the holders of preferred stock receive significant contractual and economic benefits that are not shared by the common stock. The authors point to certain valuation practices that may lead to incorrect conclusions, such as the post-money valuation approach often used by VC funds. Also, the authors note that often in arriving at valuations, the valuation may be based on the value of the most recently issued series. Usually the most recently issued series of preferred stock is senior to all previously issued and outstanding series of preferred stock, making prior series less valuable by comparison, but instead many models would ascribe the per share valuation of that senior security to every share of the other series. Using their valuation model, the authors find that 65 of the 135 unicorns lose their status as unicorns when considered based on fair value. The authors note that a lack of information regarding the differing contractual terms associated with the outstanding series of stock contributes to the overvaluation. The lack of transparency may be problematic as private secondary markets continue to grow, and as ownership of stock in privately held companies becomes dispersed. The full report can be accessed here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2955455
CB Insights recently published its seventh annual Tech IPO Pipeline Report. The report notes that in 2013, the median time between first funding and IPO for U.S. VC-backed tech companies was 6.9 years compared to 10.1 years for tech companies that went public in 2018. As we have noted in previous posts, tech companies continue to raise more significant amounts of funding prior to undertaking their IPOs. In 2018, tech companies raised, on average, $239 million before undertaking their IPOs, which is almost 1.4x the amount raised in 2017, and over 3.7x as much as 2012 figures.
The number of new private tech unicorns has outpaced the number of tech IPOs in 2018. After 2014, tech IPOs declined significantly and have remained at those depressed levels, with only 19 tech IPOs in 2018. By contrast, there were 45 tech companies that became unicorns in 2018. The mega-round financing trend, wherein companies raise over $100 million per round, was also prevalent in the tech-sector, with almost 120 mega-round financings completed in 2018.
Tech-focused private equity firms continue to acquire majority stakes in tech companies that are nearing liquidity opportunities, whether IPOs or M&A exits. However, M&A exits continue to replace IPOs. The report cites as examples Qualtric, Adaptive Insights, and AppNexus.
The recently published PwC and CB Insights’ MoneyTree Report provides insights on financing trends through the third quarter of 2018. In Q3 2018, U.S. companies raised $28 billion in venture financing despite a drop in number of deals in the most recent quarter. The dollars raised in Q3 2018 reached in a two-year high, which is attributable to large financing for unicorns, including Peleton, WeWork and Uber. The Internet and Healthcare sectors were the most active sectors. Much of the Healthcare sector activity related to digital health fundraising, including transactions for Peleton as noted above, as well as transactions for Oscar Health, 23andMe, Essence Group Holdings and One Medical Group. Among the largest deals completed in the quarter were transactions for autotech companies, Lucid Motors and Zoox. During the quarter, sixteen companies achieved Unicorn status, bringing the number of unicorns to 119.
In a paper titled, “IPO Lockup Expirations: A Persistent Anomaly of Scale,” author Kevin Green reviews the decline in stock prices following the expiration of lockup agreements relating to initial public offerings. Green reviewed all IPOs from 1988 to 2014 and then observed the trading activity around the lockup expiration. Despite the availability of information to market participants regarding the timing of IPO lockup expirations, trading activity around the time of lockup expirations still is anomalous. Trading activity significantly increases following lockup expiration. The stock price for non-VC backed IPOs declines modestly leading up the the lockup expiration compared to VC-backed IPOs, and rebounds in a five-day window following lockup expiration. However, for VC-backed IPOs, there was a substantial decline in the period immediately prior to the lockup expiration. Short selling activity spikes immediately prior to lockup expirations (which demonstrates, among other things, borrow availability) and then falls below average pre-lockup expiration levels. Short sellers do not appear to be able to predict correctly which VC-backed IPOs will decline post-IPO expiration. Green concludes that market inefficiencies play a role but the abnormal returns are sensitive to the size of the capital investment. Limits on the capital deployed or on the scalability of the investment may explain why the abnormal return patterns persist.
Authors Brian Broughman and Jesse Fried study founder control in their paper titled, “Do Founders Control Start-Up Firms that Go Public?” In their paper, the authors observe that many founders of startups lose control through the process of raising capital from venture capital funds. The authors debunk the notion that founders regain control over their companies in connection with their companies’ IPOs (referred to as the “call option on control” theory). The research shows that the frequency of founder-CEO control at the IPO is around 20% during the sample period considered. After three years following the IPO, 25% of founder-CEOs exit the CEO position for the companies that are still public. The authors also considered voting control held by the founder-CEO. Their research showed that the average founder voting power is 11.1% at the time of the IPO and 6.3% three years following the IPO. Founder voting power was higher for those companies that had received less pre-IPO financing, had undertaken fewer rounds of VC financing, undertook an IPO more quickly from receipt of initial VC financing, and had dual-class structures. Based on the review of more than 18,000 startups that received initial VC financing between 1990 and 2012, the authors concluded that it is highly unlikely that a founder will reacquire even modest control at the IPO that would be durable (lasting more than three years).
Congress has passed the Economic Growth, Regulatory Relief, and Consumer Protection Act, which principally addresses financial regulatory measures. The legislation also includes a number of securities law related provisions. For example, Section 503 requires that the SEC review the findings and recommendations of the annual SEC Government-Business Forum on capital formation and address the findings and recommendations publicly. Section 504 expands the Section 3(c)(1) exception under the Investment Company Act to include venture capital funds that have up to 250 investors and $10 million in aggregate committed capital contributions and uncalled capital. Section 507 raises the Section 701 threshold to $10 million and indexes the threshold to inflation going forward. Section 508 allows reporting companies to rely on Regulation A. Rule 509 provides closed-end funds listed on a national securities exchange and certain interval funds to benefit from the same securities offering and other provisions available to operating companies. After the Small Business Credit Availability Act was passed modernizing the securities offering and communications related provisions for BDCs, there had been concern that closed-end funds had been forgotten.
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