Pando

The number of rounds is decreasing, but the dollars keep increasing. Click, click, click...

By Sarah Lacy , written on October 5, 2015

From The Venture Capital Desk

Back in July, I predicted that the second quarter had to be peak mega round.

After all, the numbers were pretty staggering. And I reasoned that most high-flying companies that could raise a mega round, already had done so within the previous six months. Even in today’s climate most companies -- save a few decacorns-- can’t raise a new mega round every single quarter.

The third quarter numbers are coming out now and I was both right and wrong. I was right that the number of deals would fall, but completely wrong that those closing would show any return to rational prices or amounts. The number of deals fell for a second straight quarter. Meantime, the dollar amount going into companies increased yet again from $25 billion to $30 billion.

Typically the number of deals and the amount raised in any quarter are interesting to track separately, but mostly move in lockstep, like two guys in a horse suit. The back end may not move as quickly as the front, but he’ll generally stay in a certain range and catch up. That’s because both numbers show an uptick in disruption, creativity, market opportunity, and general bullishness around startups.

But something strange has been happening this year with these two numbers: They keep moving farther and farther apart. According to Pitchbook, this is the fourth straight quarter that the number of deals has declined, and the third straight quarter that the dollar amount has increased. When one number shows acceleration and one number shows deceleration, quarter after quarter, sooner or later something has to give.

If that’s not a sign that we’re clicking towards the top of a rollercoaster I don’t know what is. Will it be another quarter of divergence -- click!-- before the screams start? No one knows. But everyone knows it’s coming. This post by Caterina Fake about the coming age of the cockroach suggests that particular insect might be about to replace the unicorn as the most referenced creature in the tech world.

Not convinced?

Consider a few more stats about exits. Exit activity declined for a third straight quarter, according to Pitchbook. In the third quarter of last year there were 382 exits; this past quarter there were just 280 exits. The capital returned was even worse: Down from $24.9 billion a year ago to a paltry $12.7 billion.

That’s right: When it comes to money going into startups cash is accelerating and deals are decelerating. When it comes to money coming out of startups, cash is decelerating faster than the deals are decelerating. Those are basically the exact opposite trend lines of what VCs and LPs want to see.

Last week, one piece of evidence emerged to suggest that this disconnect between how mutual funds and hedge funds value pre-IPO private companies and actual IPOs is starting to reverse: According to the Information, Fidelity and BlackRock both marked down the value of their holdings in decacorn, Dropbox.

Click click click click.

And lest you think this is some sort of crazy Asian deals skewing all these numbers up, the numbers show the Bay Area is driving this trend. Locally, the head of the horse and the butt of the horse are basically in different counties: The Bay Area was home to 27.1% of all total global VC but just 16% of the deals. Compare that to New York where the numbers were far more range bound. It was home to 8% of all the capital raised and 7% if the deals.

It’s noteworthy that categories that are not overheated – like biotech, commercial services, media and retail – still have a tight correlation between the number of deals and the amount invested. For instance, 10 biotech deals shared a ration of $544 million between them this past quarter. Seventeen media deals shared some $290 million in capital. (More evidence of what I wrote last week: The times aren’t quite so hot for content funding as a few players would have you believe.)

The biggest divergence is in software, where 162 deals shared some $3.65 billion in funding, and in “non-core VC” where 102 deals shared some $3.8 billion.

And median valuations in San Francisco have doubled in less than a year’s time from $27.7 million in the fourth quarter of last year to $61.8 million in the third quarter of this year. Prices are going up, even as the number of deals keep decreasing. That’d be like fewer home sales closing, but the prices doubling anyway.

Click click click click.

And in case all of these totally unsustainable data trends don’t convince you things are about to correct, there’s a more anecdotal measurement: Nearly every VC with a Twitter account, blog or megaphone and a box has started screaming not only about how unsustainable everything is but how they hope it corrects soon.

Says Bill Gurley: “Burn rates are higher than they've ever been. In Silicon Valley, you have more people employed by money-losing companies probably than you've ever had before."

I’ve got a suggestion for VCs who are really worried: Stop investing in these rounds at these prices. Now sure, the bulk of these mega rounds aren’t really being done by classic VCs, they are being done by mutual funds, hedge funds, corporates, and other groups. Which is great for the VCs: They get to bitch, have plausible deniability, while  certainly benefitting in the short term from the wild up-rounds and huge cash troves their companies are able to get.

Because make no mistake: As these same VCs are telling the public how concerned they are about the prices and dollar amounts going into companies and OH GOD WILL THE UNICORNS PLEASE STOP! they are turning around and telling their companies one thing: Raise a mega round while you still can because we don’t know what’s beyond the top of this rollercoaster. And even in these “frothy” times, it’s taking on average 6.7 years to get acquired or 11.6 years to go public. You’re gonna need a warchest. 

Click click click click

Notice whenever these VCs concern troll the wild-eyed entrepreneurs, there are rarely specifics given or examples of what steps they might take to stem impending disaster. As Gurley himself has said: when a VCs lips are moving, he’s marketing. VCs love to say what the rest of the industry should do, without taking the risk of losing out should it not really be the top of a market.

Click click click click

Those who were investing back in the dot-com salad days remember the backlash and anger that turned on the VCs who’d inflated properties before pushing them out on the general public to invest in. This time, they want the “It’s coming!” blog post to point to when it all goes south.