venture capital

In last week’s Digest article – Alternatives to VC: Reconsidering the Startup Financing Paradigm – SSTI examined the conventional venture capital (VC) model as well as its advantages and limitations. In this installment, we will highlight alternatives such as revenue-based financing, venture debt, crowdfunding and a new financing model for cleantech proposed by Massachusetts Institute of Technology (MIT) researchers. We also take a look at the potential that these alternatives have for the field of tech-based economic development.

Venture capital (VC) financing is a highly competitive process that backs only 1 percent to 2 percent of all startups that apply for funding, leaving many searching for financing alternatives.  In this two-part feature, SSTI examines the typical VC model, its advantages and limitations, and next week will highlight alternatives such as revenue-based financing, venture debt, crowdfunding and a new financing model for cleantech proposed by Massachusetts Institute of Technology researchers.

Despite Brexit and political uncertainty in the U.S., stability is returning to the global VC market as investors shift from new unicorn chasing and a renewed interest in global initial private offerings (IPOs) by late-stage startups, according to a new report from CB Insights – Venture Pulse Q3 2016. CB Insights’ analysts contend that investor caution is the dominant VC market global trend driven by more realistic valuations of early stage companies, deals with a significant degree of scrutiny or investor protections, and some investors deciding to shelve their investments.

While the number of companies receiving venture capital (VC) backing continues to decline, the amount of money invested remains near record levels. As of Q3, the annual investment total for 2016 is approximately $56 billion invested across 6,000 companies. However, with only 1,800 deals made in Q3, this marks the fifth straight quarterly decline in the number of companies receiving venture investment – a 32 percent quarter-over-quarter decline.  Yet, nearly 2,000 investors deployed close to $15 billion in VC financing during Q3 2016, according to the inaugural PitchBook-NVCA Venture Monitor – a quarterly report on U.S. venture capital activity.

After an extremely strong venture capital market in 2015, the industry seems to show the signs of a decline driven by both cautious and fatigued investors. Three recent studies from Pitchbook and CB Insights indicate that there are several reasons why venture capital firms and other investors have been more cautious so far in 2016 including: mixed economic growth numbers; a volatile political climate; and, more security in private markets.

A spate of recent news challenges many common perceptions of venture capital. Academic researchers have identified critical shortcomings with widely used industry data. Major investors have revealed smaller than anticipated returns. An analysis of thousands of investments indicates fund success requires superstar deals of well more than 10x. These articles should drive new evaluations of public policy and programs to support early stage capital.

Startup failure is the rule, not the exception. However, much startup ”failure” includes businesses that made a workable product and grew — just not fast enough to attract venture capital. A hybrid venture capital-private equity approach is trying to identify these slower-growing businesses as part of an investment model that may provide an exit strategy for spurned startups throughout the country.

For the 10th consecutive quarter, the venture capital (VC) industry invested $10 billion in a single quarter after investing $15.3 billion in Q2 2016, according to the MoneyTree™ Report from PricewaterhouseCoopers LLP (PwC) and the National Venture Capital Association (NVCA). Based on data provided by Thomson Reuters, the report highlights that “total venture dollars deployed to startup companies for the quarter increased 20 percent ($15.3 billion invested) and total deal count was down 5 percent (961 deals completed), compared with Q1 of 2016 when $12.7 billion was invested in 1,011 deals.” In comparison to this time last year, Q2 2015, dollars and deals are down 12 and 22 percent, respectively.

At the end of 2015, there were concerns that the Venture Capital (VC) industry had peaked and there would be a quick return to 2013 VC investment levels. While there is still six months for the VC markets to see a more rapid slow down, Q1 and Q2 VC numbers indicate that there has only been a slight slowdown in the VC markets. However, a troubling trend from 2014 continues to dominate the VC industry – the strong VC market is driven by investment in mature, late-stage companies – either full-fledged unicorns or their slightly lower-valued counterparts. While unicorns are attracting eye-popping rounds of funding, smaller, younger startups are struggling to attract VC-backing, according to a recent report from PitchBook. In many cases, unicorns are pushing off IPOs due to the substantial rounds of funding that they receive.

The University System of Maryland (USM) recently announced a $25 million fund to invest in USM-affiliated companies or startups created by students, faculty and recent graduates.  Companies already based in USM research parks or university incubators are also eligible for funding. The system, comprised of 12 of the state’s public institutions, would invest $10 million in an early stage investment fund, known as the USM Early Stage Investment Fund (ESIF), over four years, with the remaining $15 million to come from outside investors, the state of Maryland, friends of USM and other venture capital groups.