*note: originally published on Amit Mukherjee's personal blog
With Q1 2016 nearly in the books, it’s obvious that the tech sector is experiencing a downturn. Having been on the ground as a venture capitalist for NEA through this cycle, I’ve experienced first-hand how sentiment and decision-making has changed over the past nine months across hundreds of deals that we have evaluated. In this blog post, I aim to (1) cite a number of data points that illustrate the downturn and (2) offer my own observations on how the tech sector arrived at this moment, and where we might go.
First, the data. In my 6 years following the tech financing markets, I have never witnessed such a steep and clear market movement. While most professionals at this point have picked up on a few data points and drawn the correct conclusion, describing the full set of data still shows an enlightening story:
Part I: Data
Private Market Data
1. VC investing is down: VC investing overall declined 32% from Q3’15 to Q4 ’15. We do not yet have data for Q1’16, but we can expect a similar/flattening trend.(1)
2. Companies are raising down rounds: 39 down rounds have occurred since the beginning of Q4’15. In comparison, only 19 down rounds occurred in the first 9 months of 2015.(2)
3. LP investments declined in 2015: LP investments in US VC funds declined from $31B to $28B from 2014 to 2015. LPs represent all the sources that provide venture capital firms money. LPs are constantly providing feedback to GPs on their VC performance, and they truly hold the purse strings. LP investments are a leading indicator of how prolific VC investments are. If new funds aren’t being raised, VCs have less money to deploy. If LPs are being stingier, VCs have to work harder to raise their funds (which means they aren’t on the ground doing deals). (3)
4. 91% of investors expected valuations to decline in 2016 (3)
Public Market Data
1. Fewer IPOs: Public markets stiffened through 2015, particularly in the back half of the year. There were 61 tech IPOs in 2015 versus 89 in 2014. However, in the second half of 2015, only 26 tech companies went public. And in Q1 2016, ZERO tech companies went public. (4,5)
2. Many startup companies that do IPO perform poorly: Of the 48 U.S. tech IPOs backed by VC since 2014, 35 are trading below their IPO price. As public investors lose confidence in tech companies, each subsequent tech company will find it harder to meet the bar to go public, and VC investors consider their financings in lockstep. (6)
3. Many companies are exiting at lower values than their prior private-round valuation: New Relic, Pure Storage, Hortonworks, Box and Square all went public at discounts to their prior private round valuations. (7)
4. Public market valuations have declined: BVP’s Cloud Index is down 20% since the start of the year. NASDAQ is down 3%. SaaS multiples have declined from 15x NTM revenue in early 2014 to 6-8x forward revenue to 4x forward revenue today. (8,9)
5. Great companies are down big: LinkedIn and Tableau are hailed as some of the best tech companies to have gone public in the past 5 years, and both are down big since the beginning of the year. Tableau is down 53% and LinkedIn is down 51% (10)
Operational Data
1. Over 100 startup companies laid off employees this past quarter: At least 130 companies have laid off employees since the beginning of 2016. Companies have cited “change in investor environment”. Others just really badly missed their 2015 plans. (11)
2. Employees are choosing larger companies over startups. (12)
Part II: Key Takeaways
While the data is deafening, it doesn’t explain a number of questions that any participant in the tech ecosystem will have. I try to address what are the three major questions below:
1. Sh*t. Is my startup screwed? Will I still be able to raise capital? The answer is “yes” for some and “no” for others. Good companies are continuing to raise capital at fair prices. Many anticipate that investors will take advantage of a down market, by re-introducing aggressive terms (e.g., 2x liq pref), but the tide hasn’t reversed this substantially yet, particularly for early stage companies. Many companies, unfortunately, are way ahead of their skis. We’ve seen dozens of companies who raised rounds 2-3 years ahead of where they were, and now they are coming back asking for capital, but at a hurdle rate above what an investor today is willing to pay. These companies will struggle and may need to raise capital from alternative sources, such as a strategic investor who is less focused on returns than an institutional investor.
2. How did we get here? A huge bull market followed by a correction can’t be attributed to any one factor, but ultimately this comes down to a lack of responsibility BOTH for investors and entrepreneurs. Investors at top-tier firms stopped doing diligence, trusting the prior investor and responding to hyper-aggressive competition. Companies created projections that were fundamentally illogical. They focused on valuation as a number to demonstrate success rather than simply as a tool for providing capital to build a sustainable enduring business. And employees flocked to Silicon Valley looking for “the next big thing”. Everyone was looking for fast money.
3. Will things get worse from here? I don’t know. Certainly, investor sentiment is that things will get worse before they get better, but I have struggled to find convincing data that leads credence to this theory. I would love any comments on this point—where are we going from here, and why do you think so? As I mentioned before, good companies are still raising at fair prices, so while this correction may feel painful, markets are still working.
1 (CB Insights/KPMG Venture Pule Report) https://www.cbinsights.com/research/?p=2508
2 https://www.cbinsights.com/research-downround-tracker
3 Mark Suster. http://www.businessinsider.com/mark-susters-state-of-venture-capital-in-2016-2016-2
4 CB Insights 2015 Global Tech Exits Report https://www.cbinsights.com/reports/Global-Tech-Exits-2015.pdf
5 Fortune’s Term Sheet, 3/28/16 http://fortune.com/tag/term-sheet/
6 Wall Street Journal 2/19/16 http://www.wsj.com/articles/for-silicon-valley-the-hangover-begins-1455930769?cb=logged0.6329532338969082
7 J.P. Morgan analysis, based on Dealogic and Pitchbook data
8 BVP Cloud Index https://www.bvp.com/strategy/cloud-computing/index
9 Mahesh Vellanki http://www.mahesh-vc.com/blog/understanding-saas-vs-internet-valuations
10 Google Finance. Looked at DATA and LNKD performance from 1/1/16 through 3/28/16
12 From a The Information podcast which stated that a high-flying VC-backed unicorn extended 6 data scientist offers, only to see all of them defect to Google/Facebook