Venture Capital Outlook: Despite Slow Volume, Liquidity Prospects Remain
We expect ample opportunity in the VC-backed IPO market as alternative liquidity routes gain popularity.
Despite pure exit activity coming in relatively subdued through the first part of the year, we actually see ample opportunity for VC-backed public offerings to pick up steam as we continue to progress through the next few quarters of 2018. Late-stage capital is certainly available to continue funding such companies, however, we see a plethora of increasingly mature companies that have been able to build cash-efficient business models that are attractive to institutional shareholders on the public side. In our opinion, this has been a factor of some natural maturation of the general venture market, in addition to the aging of many of the subscription-based software businesses that have received venture funding over the last decade or so.
At $106 million, the median amount of VC raised prior to IPO in 2017 came in roughly 2.7x higher than what we saw 10 years ago. Further, the median time from founding to IPO in today’s market sits at 9.4 years, and while this figure has actually trended slightly lower recently, it still comes in 3 years above the median time to exit via other exit routes, primarily strategic acquisitions and private equity buyouts. As a result, venture-backed businesses utilizing the IPO exit ramp today tend to be significantly larger, as evident by the highest proportion of companies on record to debut at a $1 billion+ market cap in 2017.
Median & Average VC Raised Prior to IPO
Median time between VC rounds & IPO (years)
Given the backlog of aging unicorns yet to move forward with liquidity events, along with the shrinkage in the potential acquirer pool that tends to occur as company valuations rise, we think many VC-backed businesses will actually move to test the waters in the public markets more so than we’ve seen in recent years. Further, while many of these companies might not have traditional fundamentals, nor earnings that match some of their public comparables, we do think that many have been able to utilize record amounts raised in the private markets to establish positive cashflow, low customer churn and high renewal rate businesses.
As a result, unit economics have improved and gross margins have increased and we think there is a subset of the market that can appreciate these key performance indicators as companies look to float publicly. Further, we think it is important to right-size the measure of success for such entities. While publicly listed shares will certainly experience volatility, the most important measure for the VCs, and subsequently, the LPs that have had their capital locked up for years is the ability for their portfolio companies to adequately price and meet their capital raise target.
In previous research, we’ve highlighted our expectation to see ample use of alternative liquidity routes by venture investors. We’ve noted three primary paths including an uptick in private equity buyouts of venture-backed businesses, an increase in SPACs used to float privately held companies, along with continued activity in the direct secondary markets. Thus far through the year, we see no reason to adjust our expectations for these events to play out. Through the first quarter of 2018, we’ve already seen a few notable SPAC filings come to market, with the most notable being the reported reverse merger of unicorn FanDuel via Platinum Eagle Acquisition Corp.
Additionally, we believe shares tendered in private secondary transactions may actually serve as a net positive for companies looking to list publicly as potential investors can gleam ample price discovery through such deals—effectively helping bankers better price and value prospective listings. We think the Spotify direct listing will be a great testament to this notion.
Spotify Private Secondary Transactions
* This figure excludes the share transfers in relation to the Tencent transaction.
Source: Spotify F-1
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