Mid Year Musings for 2016
We’re already 6 months through 2016. Time flies, right? The year certainly started off on an interesting foot. The beginnings of a much-needed valuation/market correction hung heavy in the air as 2015 came to a close. Slight fear and worry over what 2016 would hold was voiced more often than eager optimism. Was that fear and worry warranted versus what we have actually seen? And what can we expect for the rest of the year?
In terms of investment dollars, 2015 and even 2016 has seen the flow of LP money into investment funds at pre-recession levels. There has also been a dramatic increase in new investors of all sorts – angels, crowdfunding, foreign dollars, et cetera coming into the investment game – with the effect of pushing valuations ever higher in 2015 and encouraging founders to keep raising money. What some interpreted as a Series A crunch was really just a repercussion of having more and more seed funded companies looking to raise a relatively static amount of A round dollars.
Skepticism of current valuations began in late 2015 and was most apparent with the less than impressive IPO of Square. This change in valuations sparked worry that 2016 would not be as promising as 2015 for entrepreneurs and investors alike. According to one survey, nearly 75% of Limited Partners were worried about the current valuation levels and rapid pace of investment.
After the news of Square’s lower-than-expected valuation, it’s former COO tweeted that the “steroid era” for unicorns was over. However Uber‘s recent multi-billion dollar raise (despite even being profitable) has shown that some industries have not been affected by the decrease in valuations. Twilio, the first tech IPO of the year, has been a wild success, almost doubling in valuation on opening day and continuing to increase in value despite Brexit’s nasty market smash.
How has this valuation correction affected the founders and investors that I work with on a daily basis: those raising seed, Series A and Series B rounds?
For one thing, the speed and efficacy at which funding rounds are being done has slowed down – across almost all funding stages, but notably at the A/B stages. We are still seeing a solid amount of seed money accessible to early founders, although it is not as easy to raise a seed round as it was last year. Founders are encountering stronger head winds than the past few years.
At a lunch I had recently with an A stage investor, they revealed that although the fund usually only makes 5-6 deals a year, as of May there had been only one investment, and not even in the Valley. Unfortunately, the firm and the partners just were not seeing deals they were excited about or metrics that could back up deals they initially thought had potential. At a recent Silicon Valley startup panel event, one later stage investor mentioned that due diligence around deals was taking longer than usual and the fund was carefully vetting the founders and more importantly the metrics. This investor could only speak to one B round deal their firm had done as of May 2016. In working with our clients on their fundraising needs, we’ve seen that funding times have slowed down in a very noticeable way from 2015 to 2016.
In 2015 the buzzwords I heard most frequently were around valuations, caps and discounts – suggestions that investors were competing for access to invest in solid companies. These days the focus seems to be more on unit economics – customer acquisition costs and lifetime value. Founders are now being forced to switch from an environment that encouraged quick and meaty raises to one that is now more focused on numbers and true value. This is the right move and probably something that should have been happening all along. And for those founders who have always been focused on their metrics and unit economics, they will not be suffering as much to adjust. With the flood of all kinds of new investor money in 2014 and 2015, founders were advised to take advantage of as much cash as they could get their hands on. Now they are being advised to cut their burn and extend their runway for 18-24 months.
As companies raise flat or down rounds, it may be hard to get excited about the market. But for those companies and founders who can play it smart, raising a flat or down round may be a necessary step to encourage more leaner and productive growth. Twilio’s IPO has shown that there is still a very hungry public market for tech companies.
All in all, I believe that the focus on getting to profitability and delivering on metrics will build stronger and leaner companies who will be able survive this market correction. Additionally, based on some of the amazing companies I am talking to on a daily basis, there is no doubt that the number of strong companies is still high.
What will the rest of 2016 hold? For one thing, lower valuations on companies means that any future investments will be secured at better prices for investors, potentially making for better returns down the road. I am curious, yet optimistic about fundings for the last half of the year. After all, a return to sensible valuations will also mean a return of investor confidence.