United States: Venture Capital Coast To Coast – January 2015

Last Updated: February 5 2015
Article by Richard S. Grant and Steven J. Keeler

VC Watch

2014 was a BIG year for VC investment and fundraising.

Post-Bubble Records Driven by Large Deals

Concern over higher valuations? Apparently not, as $59 billion invested in 2014 breaks the post-crisis record. LPs also set a post-crisis record with $32 billion in commitments to U.S.-based VC funds. PitchBook Data, Inc., Venture Industry Report (2015 Annual). 2014 saw fewer late-stage deals, but several larger ones, as VC-backed companies are waiting longer to do IPOs. The robust public markets have created large chests of corporate cash. This fueled M&A exits of VC-backed companies like WhatsApp (acquired by Facebook). The dollar value of acquisitions, IPOs and buyouts of VC-backed companies in 2014 almost doubled that of 2013. Like investment transactions, however, the number of exit transactions was down for the second year since 2012.

So Seed Funding is Up

This overall ramp-up in both fundraising and investments produced a lot of seed VC activity as well. 2014 saw the largest number of seed VC deals since 2009. CB Insights, www.cbinsights.com. In terms of dollars invested, within the less than $5 million seed round spectrum, $1 million to $5 million rounds increased and sub-$1 million rounds took a smaller share. PitchBook notes that the increased use of convertible bridge notes may explain this in part. CB Insights notes that, although other publishers such as Thompson and Dow Jones interpret the 2014 data as suggesting seed venture capital is in decline, this is not the case. In particular, it points to the record number of micro-VC funds being formed (see "VC Players" below) and the 138 active seed stage firms that did at least four deals each in 2014 (and this does not even include corporate VC). CB Insights further notes that Series A deals (which are important to seed investors) have held steady, and seed investor sentiment is actually improved by high valuations. www.cbinsights.com.

Early Stage Still in Decline

The 2013 decline in early stage investment, as compared with both seed and later stage, continued through 2014. The success of seed stage and large later stage deals seems to have slowed the flow of money into Series A rounds, although, as mentioned above, Series A rounds remained steady or slightly above 2013 levels.

VC Players

Small Funds Win More Than Half of 2014 Commitments

In the shadow of seven "mega" fund closings, 111 funds under $50 million each closed in 2014. That's a 10-year record. Interestingly, more than half of the 2014 fund closings were sub-$50 million funds, and the total number almost tripled the 2013 level. Funds in the $50 million to $100 million range were a close second in terms of the number of funds closed. PitchBook Data, Inc., Venture Industry Report (2015 Annual); www.cbinsights.com.

VC Hubs

The Big Apple Shines: Internet and Mobile

While California bounced back to attract almost 60 percent of all VC funding in 2014 ( CB Insights, www.cbinsights.com), New York-based companies raised over $1 billion in each quarter of 2014. 2014 investments in New York were up 53 percent over 2013. Of those rounds, 63 percent went to Internet firms, and the mobile sector was in the No. 2 spot at 19 percent of the deals. CB Insights, cbinsights.com/venture-capital-2014.

Austin – Building a VC Ecosystem for Success

Texas is second, behind only California, in population, GDP, technical employment and university research and development. And now, Austin is leading a surge in VC activity, following the Los Angeles and New York scripts: revenue-generating companies in many industry sectors.

While venture capital investment in Dallas and North Texas fell in 2014 after rebounding in 2013, it was up for Texas overall (both in deal number and dollars), thanks in large part to Austin. PwC/NVCA MoneyTree Report; Data: Thomson Reuters. Austin took in most of the Texas VC investments in 2014. Much of this was due to solar company Sunnova Energy Corp.'s $250 million raise. Austin has developed a formidable VC infrastructure and is home to a growing number of promising startups and VC funds. The funds include Austin Ventures, Texas Emerging Technology Fund, Sevin Rosen Funds and Silverton Partners. Like Los Angeles, Austin is attracting entrepreneurs in software, mobile, media, cleantech, biotech, retail and semiconductors. www.builtinaustin.com. Thanks to its startup incubator, Capital Factory, Austin is becoming a good and relatively inexpensive place to start and grow a business. We expect to hear more about Austin startups like VoterTrove (voter data analytics for campaigns), Chiron Health (doctor-patience video conferencing), Togga (fantasy sports statistics aggregator), VChain Solutions (supply chain training) and Clarify (media data platform). www.venturebeat.com. Thanks to Austin, Texas is now fourth behind California, Massachusetts and New York in venture investment. www.privateequity.com.

VC Verticals

Mobile Sector: Mega Deals and Early Stage Interest

The 2014 statistics were certainly swayed by ridesharing star Uber, which raised $2.4 billion in 2014. With a $1.6 billion convertible debt investment by Goldman Sachs, Uber has raised a total of $4 billion. And, despite pushback by many U.S. and foreign regulators, many see an Uber IPO on the horizon. With additional help from large VC rounds for Snapchat, Instacart and Square, mobile sector VC funding was up 109 percent in 2014 over 2013 funding. While the large deals drove the dollar figures, seed and Series A deals constituted 70 percent of mobile sector VC transactions.

Healthcare: Fundraising Challenges and IPO Successes

2014 also set a record for VC-backed healthcare company exits in terms of dollars, but the deals were fewer and larger. Healthcare IPOs were a headline. While biotech has to compete with software and mobile companies for VC funding, biotechs led the 2014 IPO tally with 56 (and more than 60 when non-biotech healthcare companies are included). PitchBook predicts that biotech IPOs will slow in 2015, as so many companies debuted in 2014. VC investment in software has continued to climb as investors appear to be looking for quicker returns. 2014 VC investment in healthcare was one-half of its 2009 level.

VC Tips

Discounted Stock Options: Careful with the Tax Traps

VC-backed companies routinely provide their employees with equity incentives to supplement compensation packages and align the interests of founders and key managers. Some companies grant actual stock (coupled with 83(b) elections) while others issue stock options. Incentive stock options (ISOs), which permit exercise without incurring a tax liability (on the "spread" between the exercise price and the stock value), are subject to cumbersome requirements. As a result, "non-qualified" options have become more popular. Unlike ISOs, non-qualified stock options may be granted with an exercise price that is lower than the current stock value, but these "discounted" or "in-the-money" options can create costly tax consequences for the recipient if they are not properly structured.

Many people incorrectly assume that no tax is triggered upon the grant of these options, but only when exercised. While that was true under prior law, since regulations were issued under Internal Revenue Code Section 409A, discounted options are treated as a form of deferred compensation that may result in taxable income upon grant. This can occur even if the options are unvested. The consequences can be severe – a regular income tax on the difference between the exercise price and stock value, plus an extra 20 percent in tax and interest.

The rules are complex, but an option can avoid Section 409A taxation if the option is not exercisable before the earlier of (i) the date the employee's employment terminates or (ii) a change of control transaction (e.g., a company sale to a third party). The option may also avoid 409A taxation if it is exercisable and actually exercised only on a future date or event such as termination, a company sale, death or disability. In addition, options that are designed to be exercised, and are actually exercised, within two and a half months following their vesting dates may avoid adverse tax consequences.

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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