In April of last year, we wrote a blog highlighting similarities between the VC market and the Great Depression. The main theme we observed was that the concentration of capital in select venture funds would lead to fewer fundings. We cited a March 30, 2016 article in the Wall Street Journal titled Funds Flow to Venture Firms:
although “$13bln was raised by venture firms Q1, which is the most since 2000”, investors in venture funds “have become more selective, looking for managers that have been through a downturn” and more importantly “just 6.6% of firms have raised half of the venture capital money, compared with a 16 year average of 11.6%. Many prestigious venture funds have raised new billion dollar funds in recent weeks including Accel Partners and Founders Fund.”
In summary, most of the fundraising was being concentrated in the pedigreed funds like Accel (they have 20+ investments with $1bln+ valuations). We then noted how that trend was similar to the Great Depression, citing that:
The precedent is not good: one example of a major concentration of cash ending in disaster was in 1929. According to Robert McElvaine’s book The Great Depression, “more than half a century after the fact, there is no consensus as to what caused The Great Depression,” but in his view the concentration of wealth and income was the key driver. McElvaine states “in 1929, 200 corporations controlled nearly half of American industry. The $81bln of assets held by these corporations represented 49% of all corporate wealth in the nation and 22% of the national wealth.” He goes on to state “the top 0.1% of American families in 1929 had an aggregate income equal to that of the bottom 42%. Stated in absolute numbers, approximately 24,000 families had a combined income as large as that shared by more than 11.5mm poor and middle class families.” Once a small downturn began and confidence was lost, the holders of this concentrated wealth retrenched, investment collapsed, and the downturn snowballed into the Great Depression.
So was the comparison of the venture environment to the Great Depression fair? Well, according to Prequin, about 4,000 venture deals were done in North America in 2016, marking the third straight annual decline since the 6,000 deal peak in 2013. This was in spite of VC funds raising $41bln in 2016 according to a January 18th article in TechCrunch, “the largest year for VC fundraising since 2000 when the venture industry raked in a jaw dropping $101.4 billion.” Additionally, an article in the Wall Street Journal yesterday entitled Hedge Fund Ace Gets Burned in Silicon Valley said “venture capital investment plummeted 42% last year. Fidelity has slashed its estimates of the value of some of its startup stakes and Tiger Global reported double digit investment losses.” While it’s too soon to say the market for venture capital is headed towards a depression, the year over year comparison is pretty poor.
So what’s the implication for startups? High flying companies raising later stage rounds are in a better position because funds like Accel that can really only do late stage investments have plenty of cash and need to deploy it. However if you’re a Series A or B firm raising $3mm to $10mm, the market isn’t improving. As an earlier stage company, protect yourself from by being cash breakeven or at least have a plan to get to breakeven quickly if need be, or have an uncle that works at Accel.
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