THE NEW BREED OF PRE-BUBBLE VENTURE INVESTORS

The global venture capital industry is facing a crisis. It is undergoing a major evolutionary change as Wall Street, FTSE, DAX, SZSE and other exchanges embrace fewer initial public offerings (IPOs) of venture-backed companies at considerably higher valuations. It is certainly creating a different story from its past, based on investors’ new found appetite for high priced venture backed technology companies.

These IPO darlings are not all funded and mentored via traditional Silicon Valley venture capital firms, but rather, through a new paradigm of larger institutional investors and very wealthy angel investors, themselves successful entrepreneurs in their own right from innovation hubs emerging around the world.

Thousands of these new multi-millionaires have been minted by the IPOs of Alibaba Group, Facebook, Lending Club, Salesforce, Go Pro, Box, Zendesk, Pandora, FireEye, Zynga, Linkedin, Homeaway, Yelp, Zillow, Zipcar and countless others. Many of those have become formidable angel investors adding much needed market and technical advisory guidance to institutional investors. A role traditionally headed by venture capitalists.

What’s fueling the sky high valuations in the public markets, or better yet, the private markets? The venture industry has been debating the “private IPO” trend recently, as growth rounds have largely replaced traditional IPOs as the preferred financing mechanism for mature late stage startups. A surge of new money from unconventional sources has sent valuations of these startups soaring. Global hedge funds, investment bankers and mutual funds that once avoided venture deals are now actively swarming to them, paying 15 times+ next year’s revenues in order to participate in these private-funding rounds. That’s up from 10 times projected revenues as of just 5 years ago. The total amount of venture capital and IPO financing dollars in 2014 was $48 billion, compared to $71 billion in 1999 according to the National Venture Capital Association (NVCA).

SO, WHAT’S GOING ON IN VENTURE CAPITAL?

Massive late stage investments are being made in traditional venture deals by institutional investors such as hedge, mutual and pension funds that would normally limit their investments solely to the public markets. They’ve decided that they couldn’t capture the massive upside growth if they waited for an IPO. These days the very best venture-backed tech companies are staying private much longer, getting operating and growth capital at high-dollar venture valuations which are essentially substitutes for IPOs. Companies like Uber, Snapchat, Farfetch, Huddle, Dropbox, Square, Spotify, Palantir and Airbnb may appear expensive, but they have billions in revenues, are growing extremely rapidly (they are some of the fastest growing companies in history from a revenue perspective) and have real business models. There are more sources of capital available to global late stage companies than ever before. According to the NVCA, the average time for a venture-backed company to file for an IPO has gone from 3.1 years in 2000 to 7.4 years in 2013. As a result, there are more private companies worth $1 billion or more than ever before. In the past, these companies already would have gone public, instead, they are staying private, finding plenty of investors to raise capital for growth without having to endure the scrutiny that comes from an IPO. An economic shift in the capital market divide between private and public funding is clearly increasing.

Global mutual funds, investment bankers and hedge funds are jumping in on a game once dominated by venture capitalists, as they come under pressure to invest earlier or miss out on a lot of value appreciation. Uber, now a global player, out raised all others with two separate $1.2 billion rounds of financing that included Fidelity Investments, a Mutual Fund, Qatar Investment Authority and BlackRock Private Equity Partners.

These investors are offering more favorable terms to founders and early employees by providing partial liquidity in these financing rounds. These private investors at every venture stage are now getting the vast majority of the upside as it appears that the private markets are now providing a higher valuation than the public ones.

INNOVATION GOES GLOBAL

As we enter these last months of 2015, it’s clear that the venture capital industry has evolved into a much broader global capital market opportunity for public market investors. Investors are gearing up for an increase in private fundraising rounds by fast-growing European and Nordic companies, following a trend in the US where institutional investors have swarmed in as “Venture” investors in over-priced private rounds.

As the tech sector remains one of the engines of growth and wealth creation it’s clearly experiencing a continued boom, and very possibly, setting us up for another tech bubble. Experience tells me that bubbles are indeed destructive, not just for investors, but to the global innovation economy overall.

That being said, I’m a venture capitalist at heart and believe that the market tends to correct itself with greater transparency, so I’ll continue to keep my eyes open for interesting, market disruptive companies at fair valuations founded by entrepreneurs that are poised to succeed globally.

The article was written by Igor Sill, Managing Director at Geneva Venture Group