Interest Rates and Venture Capital

The Venture Capital market has experienced a massive growth in the last two decades. Startups prefer to get venture capital funding instead of raising debt. However, when it comes to economic growth, interest rates and Venture Capital (VC) go hand in hand. VC boost entrepreneurial activities and interest rates are helpful when it comes to risk-taking activities for the wellbeing of the economy.

If the interest rate is low, it serves as a fuel for VC investment, but at the same time, it discourages venture capitalists to put their money in riskier startups that are young, in other countries and in less popular industries.

Typically, VC firms invest their money after comparing the profits they achieve with profits that are available to the investors somewhere else. However, the relationship between interest rate and risk-taking can change based on which investor’s point of view is considered.

Effect of Interest Rate on non-traditional Capital

When we talk about short to medium term variations in the interest rate, it usually affects non-traditional capital source, including hedge funds and mutual funds. Unlike conventional Venture Capital investors, who keep their money invested for 10 years or so, unconventional investors can put their cash in different baskets and spread it across different assets classes. They can quickly decide where they should put their money in order to reduce the impact of interest rate variation.

Changing Effect of Interest Rate on VC Investments

Over the last three decades, federal rates have changed from as high as 16% in the early 80s to as low as 0.09%. However, VC has evolved from a small industry into a $100 billion per year asset class. Venture capitalists are investing a massive amount of money every year. Therefore, it is important to understand the changing effect of interest rate on VC investments.

Between the year 2000 and 2009, the federal fund rates and VC investments were parallel to each other. When the technology bubble was burst, the Federal Reserve adopted the strategy of decreasing interest rates so as to promote the economic growth. For venture capitalists, the environment was not as attractive as it was before and limited partners invested less in venture capital. The VC decreased with the decline in interest rates.

After the introduction of quantitative easing, this relationship between VC and interest rates ceased to exist and they became inversely proportional to each other.

Moreover, after the credit crunch, near-zero interest rate policy enabled financial institutions and brokerages to renew their balance sheets, settle their toxic assets, and revitalize their financial health. It also allowed the U.S. economy to recover from the after-effects of the crisis and enabled businesses to borrow capital at reasonable rates. During this phase of cheap money, technology sector, VC firms, and startups took advantage of the friendly valuation environment.

Federal Reserve’s Decision to Raise Interest Rates

By the end of this year, Fed plans to raise the interest rates. If the plan materializes, it will be the first time in the past nine years that the U.S. will experience the increase in rates, which will bring the era of zero interest rate to an end.

Chairman of the Federal Reserve, Janet Yellen, indicated that the increase in interest rates will not be rapid.

It will be a gradual increase, which will not change the valuation environment of a startup and technology sector instantly. However, it will change along with a valuation environment of the stock market. The reason is simple; valuation multiples are indirectly correlated to interest rates, where in, the multiples decrease with the increase in rates.

It is important to observe the next move of the Fed and market reaction to changing interest rates, because it may affect the Venture Capital market.

ICOs Surpassed Early Stage Venture Capital Funding

New startups that raised funds through Initial Coin Offerings (ICOs) have now surpassed the early stage VC Funding for internet firms.

But before diving into it, it is important to know what ICOs are.

What is Initial Coin Offerings?

This is another way of raising cash.

Cryptocurrency and blockchain startup companies raise capital through ICOs by selling tokens of investors in exchange for equity funds. It is somewhat the same as Initial Public Offering in which stocks are issued in exchange for equity. Just like crowdfunding, ICOs provide a way to get funds from users by enabling them to have a share of the business. They get digital currency in exchange for the money they invest in the business.

Rising Popularity of ICOs and VC Funding

ICOs have gained massive popularity in the last few months among blockchain and cryptocurrency startups. In April this year, the total capital raised via these offerings was around $100 million and in May, the amount went up to about $250 million. The month of June turned out to be the biggest surprise when the total funding exceeded $550 million. According to Goldman Sachs, it was the first time that it performed better than seed and angel venture capital funding. Early stage and angel venture capital funding was less than $300 million in June.

In July, the offerings were a little more than $300 million, whereas, early stage and angel funding was just a bit higher than $200 million.

Popularity Among the Celebrities

ICOs have become so popular that even the celebrities, including Paris Hilton and Floyd Mayweather, have started jumping on board. In fact, Paris has been involved in it for over a year now and also met the COO of Ethereum last year.

Total Value of ICOs in 2017

The total value raised by 92 ICOs in 2017 is $1.25 billion. This is a really good number, given the recent boom of such offerings in the VC sector. There are so many firms that have used these offerings to raise money. For example, Tezos managed to get the capital of over $200 million by creating a new blockchain, whereas, another firm, Bancor secured $153 million via ICO.

Criticism and Scrutiny from Regulators

Despite the boom, this phenomenon has been under severe criticism and scrutiny from regulators and other authorities. For example, the Monetary Authority of Singapore (MAS) released a statement in which it was mentioned that these offerings are exposed to money laundering and other terrorist financing risks, because the nature of these transactions remains anonymous. Another concern raised by the MAS was the collection of large amounts of capital in such a short time frame, which makes ICO vulnerable to high-level risk.

On the other hand, the Security and Exchange Commission (SEC) said in July this year that the security law of the U.S. will be applicable to this cryptocurrency. The experts are also showing concern over its legitimacy. They have highlighted that the sale of a cryptographic token makes the investor entitled to a certain share of profit in the firm, which can be considered as a violation of financial rules and regulations. The People’s Bank of China and a lot of other government departments have released a joint statement that people and firms that have raised money through ICO should also make arrangements to return that capital.

Firms Facing Increasing Risk of Getting Hacked

Despite all the boom and criticism, the risk of ICOs cannot be ruled out. A clear example of this is CoinDash that initiated an ICO, but ended up getting hacked in July. As a result, all of its funds got stolen. Although, it has gained popularity in the past few months, yet, the risks cannot be ruled out entirely.

Future of ICOs

The Chief Information Officer of UBS, Oliver Bussman, raised his concern and said that strict regulations and measures, as applied to IPO businesses, are required in ICO to safeguard the interest of investors. However, he is quite confident about this new mode of raising funds and expressed that such offerings will continue to happen in future. He said that as a new business model that is benefiting the blockchain technology, ICO will continue to sustain by combining hybrid equity ownership/currency and crowd funding.

Wave of Change in the VC Sector

Every day many venture capitalists invest in startups with the hope that it will be yet another unicorn. Venture capitalists are a type of investors who are also futurologists. They invest in new businesses with an anticipation that it will turn out to be the next Facebook or Uber and their investment will multiply several times.

A perfect example of such investment is the one made by Mark Tluszcz in Skype. In 2001, he invested $2.5 million and now is worth $250 million.

Investors have the chance of winning big or losing all of their investment. Tluszcz also shared his experience stating that 50 percent of the startups they invest in, end up as a failure; 20 percent of these investments only make as far as returning their investment money and another 20 percent increase their stake three times. It is the remaining 10 percent that makes it big, he added, and keep the venture capital (VC) firms going.

A Wave of Change in the VC Sector

Keeping all of this in mind, it is an undeniable truth that VC firms have undergone massive changes over the last two decades.

In the UK, the amount of investment by venture capitalists has increased from £453 million to £1961 million between 2011 and 2016. A number of these firms are filled with entrepreneurs who are passionate about building a business and not just a career.

Lack of Diversity

Despite all the changes, there is still a lack of diversity in the sector. Debbie Wosskow, a VC investor who was once an entrepreneur, came face to face with the harsh reality that 95 percent of all the investments made by venture capitalists go to male-led startups and most of these investments are made by male venture capitalists.

According to a research in Harvard Business Review, when it comes to female entrepreneurs, the focal point of venture capitalists is always toward potential losses, but with male founders, they look at it from the perspective of potential gains. Regardless of what the reason is, things have started to change in the VC sector.

Wind of Change — A Step Toward Revolutionizing the VC Sector

According to a venture capitalist, Suranga Chandratillake, said that those who present their ideas before a group of investors have to sell their idea of making it big. He further said that investors need a convincing idea that has a potential to generate good profits and not a presentation that just talks about becoming another unicorn like Uber. Investors need to see that entrepreneurs are not just into organic growth; in fact, they should be willing to take risks of revolutionizing the entire sector with a proper plan and potential to bring the right people in their team.

Self-awareness — A Trait of Successful Entrepreneurs

Another venture capitalist, Jillian Manus, believes the best ideas come from those startups where one partner has a sales and operation background whereas the other one is into technology. They come together as a team to sell their idea along with a well-devised plan of how they will achieve their goals. She added that a founder must be honest with exciting ideas as the most important question she asks the entrepreneurs is to tell how they failed. Those who say they have never failed are either hiding the truth or they lack self-awareness.

To secure an investment, a founder of a new startup should show that they have learned from their mistakes and be honest about it as it enables them to identify a problem ahead of time. All in all, venture capitalists do believe that honesty is the best policy when it comes to investing in new startups, because if an entrepreneur needs a venture capital, he or she must tend to scale up and expand their business quickly.

Venture Capital Ecosystem – Now

The current Venture Capital ecosystem has begun to revive and experienced growth in the last two-quarters. Let’s take a look at the situation of the venture capital ecosystem to evaluate the liquidity and investment position in the market.

Overview

In the first and second quarter of 2017, VC sector continued to grow despite the rolling financial market in China, Euro crisis, UK’s exit from the EU, controversial election in the U.S. and obstructed technology IPO market. Although, new uncertainties have surfaced, investors have learned to adapt and adjust. Whereas, the profits made in the first quarter further increased in the second quarter.

Funding Activity at a Global Level

The number of deals around the world has also increased. Equity funding rounds in the second quarter of this year increased by 5.7% as compared to the first quarter, adding about 300 rounds. This change took place as a result of angel investment and seed stage investment.

If you compare it with the second quarter of 2016, the overall growth in the funding rounds was about 8.8%, which came about as a result of early stage firms.

Dollar Volume

According to a report by CrunchBase, the overall investment increased by 16% in dollar terms, which is an increase of about $6.6 billion in the deployed capital. There was a fair distribution of gain. Late stage startups, early stage startups, startups at the seed stage and angels received about 20% funding in the current quarter as compared to the previous one. The only thing that faced a downturn was a technology growth rounds.

However, the global VC market is not yet restored. In the second quarter of last year, the total investment amount was $51.5 billion, but this year it was $47,8 billion, i.e., 7.2% less than the previous year. On the other hand, technology and seed sector experienced growth by 10.75% and 16.5% respectively.

Leading Investors

In a CrunchBase report, a total of 3200 VC rounds was analyzed during the second quarter of this year. During the first quarter, it was Tencent Holdings, Sequoia Capital and Accel Partners that secured the first position, wherein, each had a total of 9 rounds. In the current quarter, however, Tencent led 11 rounds, whereas, Sequoia and Accel led 14 and 20 rounds respectively.

In this quarter, some newcomers were also in the leading position, including Samsara, Grammarly, and General Catalyst. SoftBank also formed part of this list in the second quarter of 2017 along with True Ventures. Some firms dropped down from a leading position, while other newcomers made it to the top.

Technology Growth

Growth capital in the technology sector is also known as a growth equity in the business. Technology growth rounds have been defined as private equity rounds in the CrunchBase report. In these rounds, some VC investors from the previous rounds also participated as a continuation.

The dollar and deal volume also increased in this quarter compared with a volume of the same period last year. The overall increase was about 32%. The increase in dollar volume was of $160 million. Although, the deals in the current quarter were two times more than the deals in the previous quarter, the total value of funds was 45% less than the last quarter. This downfall represents the decline in round sizes over time.

Initial Public Offerings

The second quarter of 2017 experienced a small increase in the technology initial public offerings (IPOs), both in the United States and the Europe. This toned down the speculative noise that IPO window was closed for everyone except the big firms.

No significant regulatory filings or announcements were made in the third quarter of this year. Redfin, a real estate brokerage, filed documents with the Security and Exchange Commission, showing its interest to raise $100 million. And so far, it has managed to raise over $167 million from investors like Tiger Global Management, Draper Fisher Jurvetson, and others.

Although, the global VC market experienced a severe decline at the end of last year, the second quarter of 2017 was relatively better. Growth was observed in the dollar and deal volume for two-quarters back to back. Rounds are also experiencing growth; some venture capitalists doubled the bet on their investing activities. If the upward trend continues, the third quarter will bring the market back to normal after full recovery.

Why Venture Capitals should back companies with female founders?

Although, venture capital has invested a huge amount of money in the IT sector and contributed to innovative developments, yet, it still faces the same gender equality problems as any other sector does. A study by the Babson College examined the state of women in the venture capital sector. Around 7000 companies that got venture capital (VC) funding were evaluated.

According to the study, the percentage of women partners in VC firms was 10 percent in 1999, but it has reduced to only 6 percent now and venture backed companies that have female founders make 12 percent more revenue than companies with male owners. Despite that, only 2.7 percent of the companies fueled by venture capital had female chief executive officers between 2011 and 2013. Whereas, according to a 2014 research report of the Fortune, only 4.2 percent of the partners are women in the VC sector.

Issues Faced by Women in the IT Sector

Women in the IT sector have initiated a number of campaigns that are based on ‘asking for more’, especially when it comes to STEM (Science, Technology, Engineering, Mathematics) education, fair policies, mentors, pay raise, and salaries. Moreover, women have also come forward with the hardships that include unfair salary negotiation and maternity leave policies and gender bias.

These issues have led to many campaigns, conferences, and summits. However, despite all these stories of hardship and inequality, no change has come. A clear example of this is a when Ellen Pao lost her case in 2015 for gender discrimination. She claimed to have been left out of networking events because she was a female and was not promoted to be a partner while her male colleagues were promoted ahead of her.

A partner at Canaan Partners, John Balen, said that the male dominating culture begins right from the school and there should be a conscious effort to break that cycle. Candy Brush who carried out the Babson College study is of the opinion that a journey toward becoming a venture capitalist starts from your college and professional network. If 2.7 percent of the firms have females at the executive position and 15 percent of the venture-backed companies have one female on their team, it represents the small possibility of it happening.

Macro Factors – The Cause of Decline in Female VC Partners?

As discussed, the percentage of female partners in VC firms have reduced from 10 percent to 6 percent since 1999. Macro factors, including a dot com bubble burst of 2000 and credit crunch of 2008 have also contributed to the decline. VC companies had to go for downsizing during those downturns. The majority of the firms were not so big; they had to lay off on the basis of “last in, first out” – minorities and females in this case.

Another macro factor was the rising popularity of the technology market during the past two decades, especially after Facebook and Google. Having a technological edge was what mattered the most. Although, there has been a shift in this attitude, yet, there are so many investors who still want a technical partner in their team.

The founder of Brooklyn Bridge Ventures, Charlie O’Donnell, said that there are only a few females who are software engineers, therefore, it automatically leads a firm to hire more male partners.

Can Gender Equality Lead to Business Opportunity?

The managing directors and co-founders of the Women’s Venture Capital Fund, Monica Dodi and Edith Dorsen, once had a rendezvous with finance and investment professionals to talk about the more risk-intelligent approach in the VC sector. Their fund is the outcome of that meeting. Dorsen was of the opinion that the purpose of initiating this fund was to explore the untouched opportunity with female founders as a focal point. She further went on to say that firms with gender inclusive teams tend to perform better and are very competitive, but not everyone fully understands it so as to generate return out of it.

In a research carried out by Babson college, it was revealed that companies with females in the executive team are 64 percent more likely to have better valuations after the first funding and 50 percent chance to perform better at the last funding.

The founder of the Female Founders Fund, Anu Duggal, said that she visits the Silicon Valley four times a year to interact with partners of the top venture capital funds. She has observed a shift in attitude with a positive change. If the current trend continues, the VC sector and technology market might experience a major shift and massive success in times to come as it moves in the direction of gender equality.

The Key for Venture Capitalists Better Performance

Venture capital is a booming sector in developed economies. With the increasing trend in venture capital investments, a lot of research work is being carried out for its growth and continuous developments. Recently, a working paper has been posted on the National Bureau of Economic Research by professor Paul Gompers from Harvard University and a Ph.D. student Sophie Wang.

Greater Gender Diversity

According to the paper, if a venture capital (VC) firm hires a partner who has daughters, it is more likely to perform better as compared to other VC firms. But it does not mean that a girl totally understands what’s hot in the investment market and what’s not. Gompers and Wang conducted a study of large venture capital companies between a period of 1990 and 2016. They observed that the partners of the firms with higher gender diversity have, on average, more daughters. During the period of their study, it was revealed that VC firms with higher gender diversity have shown better performance as compared to firms with partners that do not have daughters.

The study also revealed that raising daughters decrease the element of biases toward women and it eventually leads to hiring more female staff. Researchers noted that firm partners who had daughters that were above 12 years of age had instilled a culture of higher gender diversity. They said that it goes hand in hand with fathers experiencing a likely gender bias faced by their daughters as they grow up.

Having a Daughter – A Step Toward Successful Deals?

72 percent of the venture capital companies do not have any female investors, therefore, the effect of having a daughter should be considered. The study conducted by Gompers and Wang comprised of 998 firms with 1400 investing partners. They employed a mathematical model and concluded that if each partner of VC firms had a daughter instead of a son, the firm would have experienced successful deals with a growth of 31.6 percent on return on capital employed than an average growth of 28.7 percent.

These calculations were based on reasons, such as, generation of better ideas in a diverse working environment or the opening of new avenues to access better deals.

The significance of “Having a Daughter” Effect

It is not astonishing, however, that by replacing a female child with a male child, the chances of hiring a female investor increases by 24 percent for VC companies. According to the study, 8 percent recruitments in the past 15 years were female and an increase of 24 percent would only represent a ratio of 10 percent in the VC sector.

The ratio of daughters in the VC sector is not so low. It represents a ratio of about 125 male children for 114 female children. This is consistent with the national demographic figure of 51 percent boys. It indicates that apart from an artificial genetic selection, the argument of daughters having an impact on the VC sector does not seem to be strong.

It has been acknowledged by researchers, because the basis of this view is mainly to eliminate the gender bias and also to emphasize its importance for the prospects of the venture capital market. Those who seek to have gender equality in the VC market can rely on the gradual change that has taken place in the sector over the years.

A Move Toward Gender Equality

In 2014, a financial market where venture capitalists operate, women represent 54 percent of the labor force, wherein, 18.3 percent of the women are board of directors and 12.4 percent are executive officers. A managing director and co-founder of the Women’s Venture Capital Fund, Edith Dorsen, is of the opinion that teams with greater gender diversity are more competitive in the market and companies with such teams have higher chances of financial growth. The majority of the people have, so far, not been able to fully understand that it is a real opportunity to earn high profits.

Anu Duggal, a founder of VC fund called F Cubed, started her firm in 2013 and the main purpose behind it was to change the common perception. She is building a network of support that comprises both men and women. This network will be focused on finding the most innovative ideas and entrepreneurs.

Evolution of the Venture Capital Sector

Venture capital (VC) industry is highly volatile. It is constantly evolving and has undergone massive changes in the past ten years due to the growth of the software sector. The shift toward the IT industry will continue to persist until one of the two situations occur:

Either the software market starts experiencing saturation as a result of huge inflow of money in the industry or
There is a manifestation of a new industry that shows higher profits, hence catching the attention of investors.

There are some analysts in the financial sector who are also anticipating another bubble bust that will be similar to the dotcom bubble in the 90s.

Rise and Fall in the VC Sector During the Past 5 Years

In 2015, VC investment around the globe experienced a growth of 19 percent. The total funding was between $128.5 billion and $130 billion, which has been the highest in the last 5 years. However, the investment continued to grow in the U.S. from $58.8 billion in 2015 to $69.1 billion in 2016.

As far as the rise of unicorn companies on a global level is concerned, it gradually declined after 2015 when the total number of startups that reached unicorn status were 71. The number reduced to 40 in 2016. On the other hand, a decline was also observed in seed funding as it dropped by 25 percent and touched the lowest point since 2012. The late and early stage investments also went down by 14 percent and 5 percent respectively.

Opportunities for VC Investors

Although, a large number of high profile investors pursue seed stage deals, they usually have sufficient funds to invest in the most attractive startup companies, which has subsequently strengthened Series A and Series B rounds.

Moreover, seed stage investments performed really well in 2014 and 2015, indicating the fact that investors who made those investments will be continuing in 2017. It will give rise to a great opportunity for investors who are seeking to make an investment at a later stage.

The momentum in the IPO will also increase, because the public sector tends to grow when valuations in the private sector are higher. It is quite likely that the IPO market backed by VC investors will outperform in 2017 as compared to 2016. For example, it has been reported that Snap Inc. is expected to offer its share at about $20 billion. If the offer materializes, it will be one of the largest VC backed IPO deal. In addition to that, Spotify, Pinterest, Dropbox and Uber are some of the names creating buzz in the IPO sector.

Rising Trends and Acquisitions

Artificial intelligence (AI) and machine learning have grabbed a lot of attention between 2015 and 2016, and they are likely to secure more investment in 2017 as well. There were more than 300 businesses that managed to raise early and seed stage funding in 2016, yet, approximately dozen secure funds at a later stage.

Moreover, a number of healthy acquisitions have also taken place recently. The examples include the acquisition of Movidius by Intel for $350 million and acquisition of virtual assistant developer Viv by Samsung.

Economics and Investors’ Behavior

There is a major role play of economics when it comes to VC investments. Since economics follow a cyclical pattern, it is highly likely that history will not be repeated nor will the unpredictable happen. Also, economics involves study of human behavior that contains an element of irrationality. This element enables us to anticipate the shifts in behavior of VC investors only to an extent of its repetition and history, but it cannot be predicted with full certainty.

VC investments change with the passage of time. As the inflow of funds increases in the software sector, it gives rise to increasing competition in the market, which eventually reduce the overall returns as several firms compete to maintain a customer base. It might also cause a shift in venture capitalist behavior in times to come if other sectors seem more viable.

All in all, the justification of a VC investors’ behavior can be summed up by saying that venture capitalists tend to go in a direction where the money flows.

Rising Trends in the Venture Capital Industry

Today, the most successful companies in the world, such as Snapchat, Xiaomi, Uber, or SpaceX have been funded by venture capital (VC) investors. The venture capital funding pattern has changed and gained popularity in different countries over the years.

In 2015, the VC market around the world consisted of $128.5 billion, wherein, 71 VC backed companies managed to reach a unicorn status along with a total of 7872 deals made.

Industries that Receive the Most VC Funding

According to a 2016 report by Martin Prosperity Institute, VC funding is available across different industries. In the U.S., software sector has around 36 percent of the VC investment with a value of about $12 billion, whereas, bio-technology and media and entertainment comprise 17.3% and 9.5% respectively. The top five industries consist of $25 billion investment constituting 76% of all VC investments.

Software sector received the highest funding even in the last quarter of 2015, i.e, $4.5 billion with 369 closed deals. On the other hand, bio-technology collected $1.5 billion via 95 deals and media & entertainment sector managed to secure $881 million by closing 114 deals.

VC Funding Trends

Venture capitalists invest in different stages of a business. According to a 2017 report by Crunchbase, the average seed funding in the first quarter of 2017 was approximately 38% higher than 2016’s first quarter funding, which shows that a number of investors are ready and excited to invest in new startups. These investors are basically accelerator programs that offer funding to newbies showing strong potential to grow in the future.

Major Cities for Venture Capital Investments

In another report by Martin Prosperity, it is stated that industry wise VC investments are also confined to small geographical locations. For example, half of the VC investments in software sector have taken place in San Francisco, representing 25% of the investments, whereas, San Jose represents 20%.

In the US, the flow of VC investments mainly comes from Boston – New York – Washington corridor and San Francisco Bay Area, representing 40% of all the VC investments around the world. In 2012, a total of $42 billion worth of VC investment was recorded worldwide. The data included 150 cities and the center point was the U.S. that accounted for 70% of the global investment, whereas, Europe and Asia only represented 14% investment.

Popular Sectors for VC Investments

Some of the popular sectors that have received a large percentage of investment are advertising, big data, cloud computing, SaaS, marketplaces, hardware and software.

Advertising – Although, it has been a center of attention for many years, but in the past 5 years, it has lost its position and the investment has decreased from 15% to only 5%. Advertising business models are gradually losing their value in the eyes of investors. One of the key reasons behind it is the heavy influence of advertising networks, including Google and Facebook.

Big data – Business models, in which the driving factor is big data, have experienced a growth in VC investment. In 2010, the series A funding comprised of 2.5% investment, but by 2015, the funding rose to 7.5%. On the other hand, seed investment has not shown any improvement or decline over a period of last 4 years.

Cloud computing – It is an infrastructure used by product developers to create services. In the last 4 years, this particular business model has also remained the same, i.e., 4%, in both series A funding and seed investments. However, it slightly went downward back in 2013 to 2014.

E-commerce – Although, e-commerce has been one of the well-known business models in terms of VC investments, yet, the seed stage investment suffered a decline from 15% to well below 10% and series A remained the same.

SaaS – In case of SaaS, series A investors didn’t perform as good as seed investors. Series A increased from 5% to 10%, whereas, seed stage experienced a surge from 5% to 15%. This sector shows attractive prospects for funding as merely less than 2% of the software market shifted to SaaS.

Marketplace – This sector experienced a surge in seed funding from 2.5% to 10% in the last four years. Uber and AirBnB are the reason behind its massive success. The current growth rate has motivated investors to consider it a potential sector for investment. Series A investment, however, remained at 5% of the dollar amount.

All in all, it is quite evident that VC investment has become one of the key sources of finance for many successful businesses and is currently dominating the world’s market at a rapid pace.

What do Venture Capitalists Look for in a Startup?

Billions of dollars are invested in new startups every year. Therefore, it has become even more important to find the answer to the following question: what do venture capitalists want?

A venture capital firm called Draper Fisher Jurvetson (DFJ Venture Capital) that has injected funds in around 2 dozen unicorns, including Twitter, Tumblr, Skype, and Box. One of its partners, Steve Jurvetson, shared his views on what he looks for in a startup when he plans to make an investment

Enthusiastic Founder

Jurvetson said that the first thing he notices is how enthusiastic the owner of a startup is – someone like Elon Musk who can convince that their idea will work. However, he added that it has to be in a sector which will contribute to the rapid growth of an economy during the times of huge disruptive change.

Innovation

In today’s rapidly changing world, innovation is a key to success. Products, such as electric cars, rockets, synthetic biology, etc., have proven to be the game changers in the IT sector. They never managed to attract venture capital in the past decades, but are high in demand nowadays. These industries have undergone massive change in the past few years, which is good for startups.

Investing in anything that takes an investor out of his comfort zone is worth it, because it leads to those crazy ideas that can change the world. However, it should be noted that it is those successful ideas that were never considered good in the beginning.

Jurvetson said that if an idea is strongly supported by a few number of people who believe it to be the future of the world, but the majority is against it, then it is a good sign.

Respect for the Team rather than Individual

Another factor he looks for is a founder who has respect for the team rather than individuals at work, a trait that contradicts the cult of a one man (in this case, a CEO) running the show. Having the self-confidence to stay humble about the proposals made and respecting the team are some of the additional attributes of a good startup owner.

What Sectors to Invest?

When talking about what sectors should venture capitalists invest in, Jurvetson hinted to Moore’s law as to how it’s penetrating into different sectors and turning lousy, low margin businesses into innovative software based businesses. Tesla is a great example that changed the course of different industries. Its contribution in the Planet labs, SpaceX, or automobile industry is a prominent example of the transitions made.

It took decades for these sectors to see entrants who transformed these industries through product enhancement. A number of investments failed during the process, yet, they are all IT based now and have gone through a massive transformation. Innovation has brought so many changes in the IT sector. For example, application of machine learning was considered a geeky subject a few years ago and only a few people at Google and other companies that worked on image recognition were familiar with the concept. But these techniques will now be widely recognized in every industry as they represent a new way of doing engineering.

A Way Forward

Remember, it is a two-way street. The world will experience the breakthroughs only if big companies welcome the evolution of technology. Jurvetson said that large companies that embraced innovation were the most exciting ones. A good example of this is Apple and its achievements over the years. Most of the large companies do not welcome meaningful innovations, which represent a connotation of disruption to depict the change. Embracing the change doesn’t mean a mere 10 percent improvement in processes, it shows a wow factor, such as freeing the automobile sector from gasoline consumption.

Similarly, back in the days, going to space was considered a tough job. Only a fighter pilot could qualify for a space mission with lots of training. But it is not going to be the same in future. SpaceX will soon launch a robot spacecraft where an astronaut will sit back and take a ride on the spacecraft. If the company is successful in doing that, space flights will become as frequent as air flights providing the same level of safety and fun.

Therefore, for a new idea to be successful, investors will have to support the change and big companies should embrace it. Not only will it be beneficial for a global economy, but will also make room for game-changing breakthroughs.

Startups Worthy of Investment … or not

It seems like those days are long gone when venture capitalists used SPRAY and PRAY strategy in the hope that one of the startups in the entire portfolio would make it big.

In other words, it is about time that startup companies show their ability that they are worthy of the venture capital (VC) funds.

Decline in the Number of VC Funded Companies

The PitchBook released the first quarter of the 2017 issue in collaboration with the National Venture Capital Association (NVCA). The statistics presented in that report were based on the thorough analysis of VC activity in the United States. According to that report, $16.5 billion was raised by 1800 companies alone. PitchBook and NVCA also observed that even though the amount of investment in the Q1 of 2017 was a bit higher than the capital invested in the fourth quarter of 2016, the number of startups has dramatically decreased to its lowest level since the fourth quarter of 2011.

VC Investors and Entrepreneurs Exercising Caution

It looks like the VC sector is facing a gradual decline after experiencing effervescent days of glory back in 2015.

John Gabbert, the CEO of PitchBook, said that during the past few years, the VC activity managed to attain intensified growth in the United States and now it seems to be coming back to earth. He further added that it feels like startup founders and investors have started following a more disciplined approach to investing the funds and taking reasonable caution by adopting measures, such as due diligence. These activities are carried out to secure fair deals on both sides so that each party gets something good out of it.

Ernst & Young, a London based auditing firm, reported that companies in the United States raised about 41.3 billion dollars in 2,802 VC deals in the third quarter of 2016. The San Franciso Bay area represented a total of 916 deals having a value of 16.9 billion dollars.

Jeffrey Grabow, the leader of VC in the U.S. based Ernst & Young, said that VC funding has slowed down and there are various reasons for the declining trend. The prominent reason, however, is the fact that investors want the market to absorb the already distributed capital in the market. Momentum capital has reached a later stage of VC funding and injected capital in almost every that was available in the market. Therefore, it is about time to see how it all turns out.

Comparison of the Number of Exits

In spite of the huge funding to a limited number of IT companies, a lot of companies fueled by $9.05 billion worth of venture capital took an exit in the first quarter of 2017. This exceeds the combined value of the IT companies’ exits in 2006, 2008 and 2009. The situation is relatively close to how it was back in 2007. If the same trend and immensity of initial public offerings and acquisitions follow, 2017 will either reach the same figure of 2014, i.e., 39.74 billion dollars, or might exceed it. Only time can tell what is to come next, but it continues to happen at the same pace, it would probably exceed the value of 2014.

IT firms around the world continue to leave behind all other kinds of businesses that are funded by venture capital. According to the NVCA and PitchBook report, Initial Public Offering of Snap and acquisition of AppDynamics by Cisco has been ranked among the top 10 biggest exits of their types during the past 10 years.

Investments in VC Activity

California has left behind all other states in the United States in terms of the number and value of VC investments. A total of 560 investments was made in 556 companies, which were worth 8.3 billion dollars. As far as the number of investments was concerned, New York was ranked second with a total of 218 investments. Whereas, Massachusetts was in the second position in terms of investment value as it was slightly higher than 2 billion dollars. Although, there may be a rising trend in the remote work among startup companies, yet, the concentration of venture capital is still high in the Silicon Valley.