In today’s capital markets, venture capital(VC)funds are competing with each other and with other sources of capital. Considering this trend, it is believed that establishing a robust venture capital value proposition for investee companies is a must-do strategy, even as 2013 is expected to be a better year.
Venture capital funds are investment funds that manage money from investors seeking private equity stakes in start-up and small-and-medium-size enterprises with strong growth potential. These investments are generally characterised as high-risk/high-return opportunities.
Theoretically, venture capital funds give individual investors the ability to get in early at a company’s start-up stage or in special situations in which there is opportunity for explosive growth. In the past, venture capital investments were only accessible to professional venture capitalists. While a fund structure diversifies risk, these funds are inherently risky.
According to Ernst & Young’s tenth annual venture capital insights and trends report, “Widespread economic uncertainty and a tough exit environment saw Venture Capital investment fall 20 percent to $41.5 billion and the number of rounds declined 8 percent to 4,970 in 2012. Amid this trend, Maria Pinelli, global vice chairman, strategic growth markets at Ernst & Young said: “Early signs suggest better exit prospects – a pre-condition for increased fund-raising and a more supportive environment for the sector.”
Outcome of the report
Venture capital insights and trends showed that average round size also decreased to $8.4 million. Mirroring the trends in investment, the total number of VC funds closed down 13 percent to 280 from 323 in 2011, and the value closed down 31 percent at $29 billion.
Investments were down in all markets and the amount of financing in the seed and first round stages dropped across all regions. The US and Europe continued to dominate – accounting for 85 percent of global investment.
Number of exits down: The number of VC-backed IPOs and M&A exits were down in 2012. The amount raised via IPO declined globally by 27 percent from $22.1 billion in 2011 to $16.1 billion in 2012. At the same time, VC-backed M&A activity declined by more than 20 percent to 618 deals.
VC funds are adjusting their investing strategies in favour of later stage companies. Globally, the share of investment directed at revenue-generative companies increased to 69 percent in terms of the number of deals (from 56% pre crisis in 2006) and 74 percent in value terms. Angel investors stepped in to fill the gap in start-up stages left by VC.
The comments
Maria Pinelli said: “2012 was a tough year for global venture capital and we saw consolidation in the market as the number of active investors declined. However, we are hopeful that 2013 will see the industry turn the corner. Steadying economic conditions will bolster investor confidence and point towards a strengthening risk appetite.
“Speeding the time to exit will help VC funds return capital to their investors, show a successful track record and get them started on the process of opening, raising and closing new funds. IPOs are still the most lucrative exit vehicle and, as post-IPO performances are increasingly important, trends point towards VCs retaining a portion of their investment post-IPOs.”
Pinelli added: “We see evidence of money flowing into companies that are perceived as less of a high-risk. There is a shift away from social media towards enterprise. Companies that are attracting greater VC interest are providing a service and getting paid for it. This trend toward later and smaller investments in less risky companies is being accompanied by a move to tougher terms.”
Increasing role of corporate venture
Corporate venture investing is rising and surpassed pre-dot-com levels in 2012. Corporates are keen to invest in and acquire venture-backed companies to fill the gaps in their strategy and innovation capability.
Corporate venture investments, which tend to be focused in the US on later stage businesses, generally have a positive impact. The valuation of the business in that round is typically greater than in companies at a similar stage with no corporate investor – the median valuation premium over the last decade has been 54 percent in the US.
VC trends by market
United States: US VC investment activity declined by 15 percent to $29.7 billion in 2012 compared with 2011. The number of investment rounds also fell, but the drop was not as pronounced, declining by 4 percent to 3,363. As of January 2013, $168 billion was invested in 8,288 companies.
Pinelli said, “The exit environment will be crucial for the US VC industry outlook in 2013. Equity markets have started the year positively, but considerable uncertainty remains regarding the resolution of the US budget, which could have an adverse impact on sentiment.”
Europe: Reflecting the global trend, European VC investments declined by 16% year-on-year to $5.7billion, while the number of VC investment rounds declined by 11 percent to 1,074. Within the overall total there was a shift towards later-stage investment, with the proportion of deals in the generating revenue stage rising from 68 percent in 2011 to 74 percent in 2012, while product development deals fell from 21 percent to 18 percent.
Pinelli said further: “Looking ahead to the remainder of 2013, with European growth expected to remain very subdued and with the trend towards tighter regulation firmly in place, the contraction in VC investment activity in the region is likely to continue.”
