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Unicorns on fire: Funding falls dramatically in the fourth quarter, along with exits of all kinds

By Sarah Lacy , written on January 7, 2016

From The Venture Capital Desk

I predicted the second quarter of 2015 had to be peak mega round. Turns out, I was three months off. But now it’s official: The shit is hitting the fan.

CB Insights is busy preparing its year end venture capital report and decided to do a mini-release of some of the data today, because the fourth quarter data was just so much worse than they expected.

In the third quarter, venture funding hit dot com funding levels with 2008 deals and $38.7 billion raised. In the fourth quarter, we saw the lowest deal tally since 2013, with just 1743 deals raising some $27.3 billion.

Funding fell 30%, deal activity fell just 13%. Why one more than the other? In a word: Mega rounds.

Mega rounds were cut in half in the fourth quarter, compared to the previous quarter. In the third quarter there were 72 rounds for more than $100 million. This past quarter there were just 39 of them. In dollars, collective mega rounds made up $20 billion in funding in the third quarter and just $11.7 billion in the fourth quarter.

And as you'd imagine the number of new unicorns fell too. Just nine new unicorns entered the club, compared to 58 in the rest of the year combined.

Interestingly we saw the pullback across North America and Asia at the same time. Typically, the rest of the world lags a correction in the Valley. It's another sign of just how quickly the reins were pulled across the board.

For the bulk of the year, we'd seen a strange trend where the amount invested kept increasing quarter-over-quarter, while the number of deals being done kept falling. I've been arguing since October that that trend was the clearest sign possible that a correction was days, weeks, or at most months away.

From that piece:

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.

It was also exactly what we saw just before venture funding fell apart in the wake of the dot com crash. People think it all stops at the same time. In truth, overall deals fall, while investors double down on the best companies, worried they won’t be able to raise capital at these levels again. For months now, smart companies and the VCs advising them have known a correction is coming and have tried to raise as much as possible to survive.

The rosy way of looking at this data is that with so many mega deals completed in the second and third quarters of 2015, many of those 140 or so unicorns have plenty of capital to survive, if some austerity measures come into play. I’ve called this the TellMe playbook. A rosier justification still: Of course funding fell, because everyone who can raise a mega round rushed it through the system already. Who was left?

There's some truth in both of those views for a handful of rarified companies. And then there's everyone else. Fear has set in, as you see from the fact that funding is drying up across the board, not just at the mega-round and unicorn levels.

The dramatic decline in the number of deals -- coupled with the previous six months of a decline in deals we've been writing about-- suggests this is about far more than just megadeals and unicorns. The correction is going to be felt at all stages. There will be collateral damage. Companies that hadn’t yet proven themselves, but in another market would have been good enough to raise another round will be abandoned at all stages of the process.

People always say “The great companies will get funded in any market.” Listen for it: VCs will say it over and over again this year. Well good for them. But anyone who has actually built a company-- including fucking Elon Musk-- will tell you that even the greatest companies go through long periods where they don’t look like a “great company.” A correction during those times can be devastating.

People always wonder why late stage trends or even public market sentiment affects what seed stage investors do. After all, a company funded for the first time now, has years before it has to worry about an exit. Some of them just lie and say it doesn't affect them, while frequently their actions show otherwise.

In recent months, seed investors have explained to me that they have to see themselves as part of the entire venture capital food chain. If companies can't go public, late stage pulls back (ta da! That's likely the biggest immediate catalyst for the fourth quarter correction given how atrocious the third quarter exits were).

That means VCs who are already loathe to do a lot of Bs and Cs worry there's no one out there to do the expansion round, and they sure as shit don't want to have to worry about an IPO to keep the company going. And that means As get compressed. The odds of a seed deal getting to a series A was already about 30%, even in a roaring venture market.

Put another way: We’re in a big cosmic game of musical chairs. The market suddenly removes one-third of the chairs. It's against seed investors’ interest to keep the same number of new people entering the game. It hurts the companies that are already playing. Seed investing in a market like this is not about an eventual IPO for a company being formed today. It’s about all the steps a startup needs to make to get to that point.

For what it's worth, Pitchbook too released some stats today arguing that 2015 was all but certainly the peak of venture capital. Their third quarter to fourth quarter math revealed a decline of 16%-- not nearly as dramatic, but an equally clear sign that backs up exactly when investors pulled way back.

Hopefully smart startups have raised as much as they could over the previous 12 months that everyone has been wailing about a correction. Bill Gurley has practically been a one-man Greek chorus. Hopefully they have cut spending or at least drafted an austerity plan they can enact if things get worse. If they haven't done that already, if they’ve ignored all the warnings, the options aren't great.

There is nearly $90 billion in funding sitting in companies that need to go public or sell at some point in the next year or so. That's a shit load of inventory at a time that companies have pulled way back on acquisitions because the valuations are so high and no one wants to do the next generation of the AOL/Time Warner deal, and the public markets are in a foul mood.

With the hot money fleeing the late stage scene, this will likely be a year dozens of companies are forced to go public at less than advantageous terms. That will hurt employees most of all, as we've written before.

On the early stage scale something similar is happening: Acquihires-- the one time guaranteed soft landing if you or your VCs were connected enough-- are done too.

CB Insights published research on this too recently. Yahoo, Google, Facebook and Dropbox all pulled back on these deals in 2015. This was inevitable after the flood of acquihires in 2013 and 2014, in part because it was driven by catalysts like Yahoo having shit loads of money and pressure to devour talent and ideas. But acquihires are a horrible way to do that. Entrepreneurs frequently view their years inside an acquiring giant as something between "vacation" and "the penalty box." They draw a great salary, work eight hour days, take vacation, vest and think about their next ideas, and then leave.

But it’s fascinating how exits are being slammed from all sides: IPOs, big acquisitions, and tiny acqui-hires. The system has been so flooded with companies and capital and high prices, that big companies are wise to just sit back and watch this play out.

So what does this mean for the age of unicorns? CB Insights did a poll last year asking whether or not people thought there would be more or fewer unicorns by the end of 2016. The results were split down the middle. I argued there will be more for two reasons: Startup valuations are a lagging indicator that only change when there's a catalyst like a deal to change them. Many of these companies have raised so much cash, I don't see their valuation falling that far that fast. And some new unicorns will continue to be born. Just as we saw this quarter, even a collapse in funding at the late stage level yielded nine new unicorns.


Amid the froth, there are real companies that are worth billions of dollars. The angst and pain of the next twelve months will be the market determining which ones those are.

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