United States: Venture Capital Coast-To-Coast

Last Updated: November 23 2014
Article by Steven J. Keeler and Richard S. Grant

VC Watch

We watch venture capital quarterly trends like everybody else, and are consistently surprised how much the "macro" statistics mask more telling "micro" or sector trends.  While the 2014 Q3 news highlighted the drop in VC fundraising and investment from the prior quarter, this will still be the biggest year for VC activity since the Great Recession.  Several stories within the big 2014 story have caught our eye.

Small and First-Time Fund Come Back

The median fund size raised was $119 million in the first three quarters of 2014.  Dow Jones Venture Source U.S. – 3Q 2014.  The number of new seed and early stage funds, including first-time players and seed funds formed by larger VC firms, has consistently increased through the first three quarters.  Although Q3 2014 fundraising was down from Q2, the number of new or first-time funds raised in Q3 increased as compared with Q2.  Thomson Reuters and NVCA, Year to Date VC Fundraising Surpasses Full Year 2013 Commitment Levels.

The big story of the last decade was the contraction in the number of VC funds.  But the new story may be the "bifurcation between a small number of very large venture firms who are investing funds well in excess of a billion dollars and much larger number of smaller VC firms."  The Future of Venture Capital, Tech Valuations and the Fate of Tech Incumbents – Conversation with Bill Janeway, www.forbes.com.  The new class of $100 million or smaller funds should increase the number of seed stage deals going forward.  The first half of 2014, as compared with 2013, saw no increase in the number of seed stage deals (and they were smaller on average), with fewer (but larger) early stage, expansion and later stage deals. McGladrey Semi-Annual 2014 Venture Capital Market Trends Report

Strategic Exits Still Rule

IPO activity has fallen in each quarter of 2014 while M&A activity for VC-backed companies set 3-year records in Q1 and Q3.  While the resurgence in IPOs is frequently cited as one factor in VC's historic comeback, acquisitions have accounted for more than 80% of VC exits since 2001, according to data from the National Venture Capital Association.

Bubble Talk 

The VC media is inciting fears of a new VC "bubble."  Non-traditional VC investors, including cash-rich corporates, have pushed valuations to high levels, and the public markets have helped with that push.  The result has been a drop in the number of VC investment deals while total capital invested is approaching a post-2001 record.  Reasonable minds can differ on whether there is a bubble building but, as Pitchbook reports, the "institutionalization" of seed investing has produced more stable and "valuable" companies raising their A, B and C rounds.  PitchBook, VC Valuations & Trends, 2H 2014 Report.  Valuations will eventually cycle back down just as the public markets will eventually cool.  But with markedly more company and investor discipline today than was the norm in 2000, higher valuations do not necessarily portend another bubble burst.

VC Players

Corporate Stars and Healthcare IT Example

You hear a lot about angels, family offices, hedge funds and, of late, even mutual funds stepping up their VC investment games.  However, it is hard to overstate the importance of corporate investors to the VC ecosystem.  In Q3 2014, corporate venture accounted for 10% of all venture dollars invested and over 17% of venture deals.  As with VC general, corporate venture investing should set a new post-2001 record in 2014.  According to CB Insights date, digital health and health IT attracted $2.2 billion in the first half of 2014.  This, thanks in substantial part to the likes of Google, Merck, BlueCross BlueShield and Qualcomm.  Examples include Google Venture's $130 million Series B investment in Flatiron Health, Kaiser Permanente Ventures' $41 million Series B stake in Health Catalyst, and Qualcomm's $32.5 million Series C round with Telcare.  Since 2010, 41% of corporate investments have been at the early stage and 36% at mid stage.  Corporate Investment in Digital Health & Health IT Industry Hits Record Level, www.cbinsights.com/blog/corporate-digital-health-investment-2014.

VC Hubs

The Other California

Los Angeles and the Southern California region had the 4th largest number of deals in Q3 (behind the Bay Area, Boston, and NY) and the 3rd highest fundraising (beating out Boston).  Dow Jones Venture Source U.S. – 3Q 2014. Increasingly, LA is now recognized as "another VC hub," next to NY, Boston and Seattle, with total dollars invested in LA up 23% over 2013.  LA boasts well-funded companies like NantHealth, which recently raised a $250 million Series B equity round.  VC Hub Battle Royale – NY vs. LA vs. Seattle vs. Massachusetts, www.cbinsights.com/blog.

VC Verticals

Ed Tech

Most of the bar and pie charts still have software and biotech at the top of VC investment activity.  While companies providing technologies and services to the education sector do not often get a separate mention, we all know that, like health care, education is a heavily-regulated sector in need of innovative solutions and which attracts many affinity or impact investors.  Ed tech is more mature than sectors like clean tech and healthcare IT, so the space is more crowded.  But it should continue to be a popular sector bringing companies and investors from all over the U.S. together.  Reston, Virginia-based Echo360 just raised $18 million in its latest round (bringing its total VC investment to $67 million), thanks to lead investors Duchossois Capital Management (Elmhurst, Illinois) and New Island Capital (San Francisco), who join incumbent Revolution Growth (Washington, D.C.). According to Law360, private-equity backed Blackboard just announced that it has agreed to buy ParentLink, a provider of communication services linking school district staff to student families. www.law360.com/privateequity/articles .  Ed tech deal activity has declined in 2014 from 2013 and 2012 levels as investors focus on funding existing portfolio companies and looking for new themes.  Smart VCs are Getting Bearish on Ed Tech, www.cbinsights.com/blog/smart-venture-capital-ed-tech.  According to CB Insights, the most active ed tech investors are transitioning to mobile language learning (e.g., Sequoia Capital and Mindsnacks), teacher-student collaboration and communication (e.g., Kleiner Perkins and Remind), education and analytics (e.g., First Round Capital and Civitas Learning), coding and programming education (Greylock Partners and Treehouse), and online courses and tutorials (e.g., Andreessen Horowitz and Udacity).  Where is the Smart Venture Capital Money Going in Digital Health & Health IT? www.cbinsights.com/blog/smart-venture-capital-digital-health.

VC Tips

8 Steps to Keep Board Seats from Getting Too Hot

VC fund partners and company founders routinely sit on portfolio company boards of directors.  Directors have fiduciary duties to all stockholders, not just themselves or their funds.  Fulfilling these duties can become especially challenging during successive financing rounds and exit transactions that may impact different stockholders differently.

Here are some "best practices" that should reduce the liability exposure of directors:

1.         Act as a stockholder, not as a director.  An investor can avoid director duty issues by exercising rights as a stockholder under the company's charter and stockholders agreements.  In negotiating VC documents, it is therefore important to get key rights into these documents and not subject them to board votes.

2.         Make sure the corporate documents contain the maximum director protections and indemnification allowable under the law, and require the company to obtain director and officer liability insurance.

3.         Fund investors should insist that the legal documents absolve their board appointees from any obligation to make other investment opportunities available to a portfolio company or to refrain from making competitive investments.

4.         Avoid rash or rushed board decisions on significant financing or exit transactions.  Prepare for and participate in board meetings.

5.         Keep adequate records and minutes of meetings describing the board's decision process.

6.         Seek the advice of attorneys, investment bankers, accountants and other experts where appropriate in connection with significant transactions.

7.         Consider having major transactions reviewed and approved by a committee of independent directors who are neither controlling stockholders or company executives or who have no personal financial interest in the transaction.

8.         Disclose conflicts of interest and endeavor to have transactions in which one or more directors have a personal interest approved by directors who do not.

Good board practice is good risk management, and a well-functioning board should also enhance portfolio company performance and investor returns.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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