United States: Venture Capital Coast To Coast – June 2015

Last Updated: June 25 2015
Article by Richard S. Grant and Steven J. Keeler

VC Watch

VC Investments "Barrel Ahead" While IPOs Dip (and Rebound?)

As we reported in January 2015, 2014 was a banner year for venture capital on all fronts, from fundraising, to investment and exits – save, however, for the small drop in the number of deals versus the largest aggregate dollar investment since 2000. The momentum and deal-size trends continued through Q1 2015, with the highest VC funding for any quarter since 2000 and the highest median valuations on record. Fewer, larger deals continued through Q1 2015, which saw $13.4 billion in total VC investment. www.pehub.com; MoneyTree Report, PricewaterhouseCoopers and NVCA based on data from Thomson Reuters . A Dow Jones VentureSource study actually estimated a final Q1 2015 total of $15.7 billion investment in U.S. startups and Prequin puts the Q1 2015 number at $16.3 billion. Big VC plays on later-stage companies totaling $4.2 billion (a 62 percent year-over-year increase) included SpaceX's $1 billion raise and a $530 million round for Lyft. There were no noticeable shifts in industry group allocations, with software, media, consumer internet and biotech continuing to lead the pack. Dow Jones Venture Source.

But as most expected, VC-backed IPOs dropped in Q1 2015, in fact, to the worst level in two years. Drop in IPOs Could Be Trouble for VCs, The Wall Street Journal, April 7, 2015, B4 ("While venture investments appear to be barreling ahead, venture exits via IPOs dropped."). Total VC-backed company exits, including M&A, also dropped in Q1 2015. (Total exits including M&A dropped from 255 to 181, and total dollar value declined by 65 percent.) As we await the Q2 2015 statistics, some commentators are asking whether the current investment levels are justified by the declining exit environment. Venture Capital Dispatch, blogs.wsj.com. The more bullish insist that the first quarter IPOs of GoDaddy Inc. and Etsy Inc. prove that the IPO door is not closing and, more importantly, that investors in later-stage technology companies have the capital to keep them private longer. In fact, the early Q2 2015 reports suggest that there are some 16 companies (mostly software and life sciences) preparing for IPOs. 16 Cos. Polish $2.8B in IPO Plans, www.law360.com, June 15, 2015. The performance of IPO stock prices has, admittedly, been mixed. Apigee and Box are both trading below their pre-IPO VC-implied valuations. VC's 2014 performance set off a rash of blog and website predictions, including an "IVCA Feature: Online Predictions for Venture Capital and Private Equity in 2015" that cited our own "Private Equity 2015" question whether LPs would continue to bet on the "upper" and "lower" ends of the "middle market." www.illinoisvc.org. So far, that seems to be the case in both venture and private equity; small and mega deals are outpacing the middle.

The number of U.S. "unicorns" – VC-backed companies valued at $1 billion or more – now number about 70. Ride-sharer Uber tops the list, with photo-messenger Snapchat (which only recently began generating revenue) close behind.

With the hard lessons of 2000 having been learned, today's VC investors appear more rational and aware that nothing lasts forever. Thus, one hopes, this time around, eventual valuation adjustments and the reality of longer holding periods will be met with investor patience and renewed emphasis on company fundamentals and bottom lines.

VC Players

SPVs and Co-Investment Trend

We previously mentioned the increase in the direct investment appetite of angels, family offices and hedge funds. But institutional funds are also stepping up co-investments and "special purpose vehicles" (SPVs) to fill out large VC rounds and make direct investment bets on the most promising companies. Andreessen Horowitz and FirstMarket Capital − along with other VC funds, self-made entrepreneurs and family offices − are raising tens of millions of dollars for direct investments in single startups. Certainly this is being driven in part by larger VC raises, fueled by ballooning valuations. Direct investments allow funds to deploy a lot more money in a single company than they otherwise could. These SPV investments typically include a carried interest of between 15 percent and 20 percent (similar to that of LP fund investments) but are often free of management fees. FirstMarket's stake in Pinterest Inc. is a good 2015 example of this trend. While this SPV trend is being reported primarily with respect to the 70 "unicorns" that have commanded $1 billion or better valuations in the past year, due to the increase in the number of small VC funds and continued interest in seed and early preferred rounds, we see co-investments and SPVs on the rise for much smaller companies and rounds as well. As we also previously reported, many of the new, smaller funds offer their angel and family office investors co-investment opportunities to leverage the fund's reach and satisfy the growing appetite of LP investors for direct investment opportunities. The caveat for SPV investors who are not also LPs in the sponsor fund: SPV investors get much less information about the target companies. Facebook and Twitter can be thanked in part for this SPV or co-investment trend. And investment banks and their wealth management arms are inviting many wealthy investors and families to SPV opportunities. A New Inside Track to Hot Startups, The Wall Street Journal, Friday, April 3, 2015, page B1.

VC Hubs

College Towns

Our previous reports attempted to highlight VC-friendly locales beyond Palo Alto, Boston and New York. We featured "secondary" VC hubs like Austin, Texas, which like Boulder, Colo., are gaining VC clout. When the number of first-round financings (obviously dominated by San Francisco, Boston and New York) are "normalized" by relative population or translated to a per capita comparison, it is clear that smaller cities offering a university-based environment and unique quality of life can support successful companies. For sure, large metro areas will continue to dominate the VC scene. But the "new names" that crack one study's top 20 list caught our attention: Charlottesville, Va.; Boulder, Colo.; Ann Arbor, Mich.; and Champaign, Ill. – all homes to prestigious universities and desirable places for wealthy individuals, family office executives and financial services professionals to migrate from the big cities and live. A company can raise capital anywhere in the U.S. if it has the right stuff. Brookings, The Avenue, Rethinking Metropolitan America, www.brookings.edu.

In Between the Coasts – A Fly Over Kansas City

Kansas City is like many large U.S. cities in its desire to encourage the development of an entrepreneurial infrastructure. But, like Austin, Texas, and Miami, Fla., it understands that a well-rounded VC ecosystem demands local VC funds. Flyover Capital was founded in 2013 and announced its first investment in 2015. Flyover invested $1.75 million in Opendorse, a professional athlete marketing solutions provider based in neighboring Lincoln, Neb. Consistent with our observations about the growing number of smaller funds, Flyover has raised $40 million and may get to $75 million. The impact of smaller and first-time VC funds should be both economic and geographic, and we applaud Flyover and their new generation of company-building funds located, not on Sand Hill Road or Wall Street, but on Main Street, U.S.A. KC's Newest Venture Capital Fund Makes First Investment, Kansas City Business Journal, April 20, 2015, www.bizjournals.com.

VC Verticals

Ag Tech

The agriculture technology sector overlaps with biotech, software and other more traditional venture capital industry groups, as well as manufacturing, distribution, supply chain and, of course, food. Ag tech is leveraging consumer preferences for sustainable farming practices, plant and animal health, and all things organic and local. Ag tech also is developing solutions that help large agriculture conglomerates with food safety. And, ag tech innovations are going directly to farmers, growers and nurseries with solutions to enhance profitability.

The marketing, M&A and regulatory landscapes for large food producers and retailers, as well as farm products companies, is in constant motion. Taco Bell and Pizza Hut, and even Panera Bread, are following the lead of others to remove artificial flavors and colors and trans fats from their food. Large food companies and their retail customers are acquiring complimentary product lines and new brands: Hormel recently agreed to buy Applegate Farms (whose customers include Whole Foods and Trader Joe's), General Mills bought Annie's, and Campbells acquired Bolthouse Farms. Hormel Will Buy Applegate, Gain Organic-Meat Foothold, The Wall Street Journal, May 27, 2015, B3. Agriculture product companies are diversifying into complimentary product lines. Giant seed maker Monsanto has been looking at a potential deal with pesticide supplier Syngenta. Farmers Sweat a Monsanto Tie-Up, The Wall Street Journal, June 8, 2015, B1. Although a recent flurry of announced IPOs involved mostly software and biotech plays, Law360 reports that Wayne Farms Inc., a poultry processing unit of Continental Grain Co., announced its IPO on June 15.

Poultry producers are curtailing antibiotic use in poultry production, while they confront new outbreaks of avian flu. Foster Farms Joins Push to Curtail Use of Antibiotics to Raise Poultry, The Wall Street Journal, June 2, 2015, B6; Pilgrim's Pride to Curtail Antibiotic Use in Chickens, The Wall Street Journal, April 21, 2015, B2; Joining Flock, Tyson Acts on Antibiotics; The Wall Street Journal, April 28, 2015, B3; Bird Flu Outbreak Spreads, The Wall Street Journal, April 21, 2015, B1. Animal rights groups, big-box food distributors and restaurant franchises focused on consumer preferences are pressuring corporate food producers to improve the treatment of animals. Wal-Mart: Food Suppliers Must Treat Animals Better, The Wall Street Journal, May 23-24, B3. At the bottom of the supply chain, farmers are struggling to increase their efficiencies and profits in the face of increased production, rising seed and chemical prices, and a decline in crop and livestock prices.

New companies are providing technological advancements in crop production and food safety. Flagship Ventures partner Ignacio Martinez observes that partnering with giant companies can be easier than competing with them for farmer dollars. Ag technology: It's now what's hot for venture capital investors, Delta Farm Press (Online Exclusive); NA, June 08, 2015, Penton Media, Inc. Seattle-based iFoodDecision-Sciences is selling mobile applications that enable food processors to collect and analyze data to prevent disease outbreaks and product recalls. When E.Coli Becomes a Business Opportunity, The Wall Street Journal, May 15, 2015, B1. Farms and nurseries are replacing some of their labor with planting and harvesting robots. Goodbye Field Hand, Hello Fruit-Picking Robot, The Wall Street Journal, April 24, 2015, B1. Symbiota provides seed coating with microbes that help plants become more drought- and heat-tolerant. Dupont acquired a similar microbe product company, Taxon. Syngenta helped launch AgrMetis, a natural pest-control chemicals startup. The Farmers Business Network is a social network, backed by Google and Kleiner Perkins, that collects data on seeds and soil to assist farmers with crop yields and performance. Blue River Technology and other startups are developing robotics and drones to increase farm productivity. Data collection will allow farmers to better manage crop rotation, water management and the use of pesticides. Agriculture Technology is Catching On: Here's Where to Invest, Wall Street Daily, www.wallstreetdaily.com. Ag tech and science companies have been around for a while. Vestaron, started in 2001, makes an eco-friendly pesticide from spider venom and obtained EPA approval last year, allowing it to pursue sales to vegetable and greenhouse growers and, eventually, home and garden uses. Venture Capitalists Return to Backing Science Start-Ups, The New York Times, www.nytimes.com.

As has been the case in the energy and life science sectors, the convergence of consumer preferences, farming economics and food safety regulation are driving a cottage industry serving farmers, food producers and agribusiness conglomerates alike. As in other sectors, the most likely acquirers of ag tech startups are partnering and investing in them as a way to outsource their own research and development. Monsanto Growth Ventures will invest in seed stage through Series A and beyond. Its website lists areas of interest such as IT solutions, robotics and automation, software, water and soil management, biotech, breeding and new crops, crop protection, and ag biologicals that support plant health naturally. Dupont is also active on the investing and acquisition fronts of ag tech. Bayer CropScience acquired biotech company AgraQuest in 2012 for $425 million. VC funds increasingly are focusing on ag tech and new funds are being formed. The AgTech Innovation Fund, based in Northern California, is being organized to invest in early-stage ag companies. www.bizjournals.com.

VC Tips

What to Offer the Earliest Investors: Equity, Convertible Notes or a "SAFE"?

Founders, investors and VC lawyers have been seeing a new alternative to convertible notes and equity. The simple agreement for future equity (SAFE) streamlines the fundraising process for the founders, but the reaction from investors has been slow and mixed. The SAFE form was developed in 2013 by Carolynn Levy, an attorney at Silicon Valley accelerator Y Combinator. A SAFE is like a freestanding warrant (i.e., a warrant that's not attached as an equity kicker to a debt or equity investment). The investor does not have equity, but only the opportunity to receive equity if and when the company raises capital, is bought or goes public. But a "SAFE" is not debt nor an "I owe you." It does not even have a maturity or interest rate. If the company fails, the investors get nothing. Unlike debt or equity holders, but like a warrant holder, a SAFE investor has no legal claim to the company's assets. Like a convertible note, a SAFE allows the founders and investors to bypass setting or agreeing on a current valuation of the company's equity. It is difficult to determine how common the use of SAFEs has become. The ability of a startup to convince seed investors to go the simple and quick route and use a SAFE obviously will depend on the startup's story and negotiating leverage and the investors' appetite for return and aversion to risk. Startups Offer Unusual Reward for Investing, The Wall Street Journal, April 2, 2015, B7.

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