Guest Contributor September 03, 2015
Many would agree that company financing dynamics in venture capital have changed in recent years, especially with respect to valuations rising, round sizes increasing and companies staying private for longer. From my vantage point, these dynamics are contributing to an accelerating pace of VC fundraising. The story told below using PitchBook data explains partly why early stage VCs have been coming back to fundraise faster and why this trend may persist if financing dynamics continue at their current pace.
What is the state of U.S. VC fundraising today? Many more venture funds are raising capital now than in recent history. The current pace in 2015 is expected to surpass 2014 in both total capital raised and number of funds closed.
So what are some of the dynamics causing this accelerating pace of VC fundraising? First, as everyone knows, valuations are up, which equates into round (or deal) sizes being up, too. With bigger round sizes, VCs are required to write larger checks to maintain their ownership targets. Larger checks deployed per round also means that capital is deployed faster on a per company basis than it has been historically for the same strategy.
Following is a deeper dive of the chart directly above: round sizes have increased in angel/seed deals, so, as mentioned above, angels and seed funds are putting greater amounts of capital in initial financing rounds.
In follow-on rounds, seed funds and early stage funds are also deploying larger checks to protect pro rata, turning reserve models on their head. Thus, for these smaller funds, more capital deployed in initial rounds + more capital deployed in follow-on rounds = faster deployment of fund capital.
Further, median time between rounds has decreased, as shown below. So effectively, not only are VCs writing larger checks across initial and follow-on financings, but they are also writing those larger checks at a faster rate, leading to funds being fully invested at a faster rate. Moreover, the expectation of having to reserve more capital for follow-on rounds could lead VCs to reserve more capital than in the past.
On average pre-2010, a firm may have raised a follow-on fund every three to four years. Now, funds appear to be raising much faster, as shown by the graph below. This compression is also affected in part by firms raising more SPVs (special purpose vehicles), but the trend is indicative of the sheer number of vehicles now investing in VC.
In addition to fundraising faster, subsequent follow-on funds are responding to larger round sizes and the need for more reserves by getting bigger, with a median fund step-up multiple of 1.2x year-over-year since 2013. This means that over the last few years a VC that raised $50 million for Fund I raised on average $60 million for Fund II.
The data also shows that the average fund size continues to tick up (despite the median fund size staying relatively constant), potentially driven by funds raising more capital to protect pro rata, among other reasons.
Based on the current dry powder overhang of $76 billion in the U.S. VC market1, and the current LP enthusiasm for committing to VC funds, we believe increased valuations could stay elevated in the near term (especially considering some of this dry powder in funds is no doubt being reserved for follow-on financings), thereby perpetuating the company financing dynamics and this faster pace of fundraising.
In summary, larger round sizes plus shorter times between financings has led to larger funds being raised faster, in particular for early stage funds. Although LPs have found venture capital compelling over the last few years, it remains to be seen how the fundraising landscape evolves, especially as current funds return to fundraise with largely unrealized portfolios.
1 Statistic based on PitchBook’s 2H 2015 PE & VC Fundraising & Capital Overhang Report
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