United States: Venture Capital Coast To Coast – August 2015

Last Updated: September 3 2015
Article by Richard S. Grant and Steven J. Keeler

VC WATCH

Halftime 2015: On Pace to Match 2014?

Venture capital activity for 2014 was a hard act to follow. But 2015 has not disappointed so far, with fundraising and investment continuing at an historic pace. A total of $20 billion was raised by U.S. venture capital firms in 1H 2015, with large and small micro-VC funds continuing to increase their share of the VC market. On the investment side, while deal count is down, dollar volume is up: A new post-2000 record $7.1 billion was invested in early-stage deals in Q2 2015 and seed-stage activity is up. And in Q2, there was heavy investment of angel seed capital, along with $2.2 billion of angel and seed capital deployed across 763 rounds. PitchBook Data, Inc., PitchBook 3Q 2015, U.S. Venture Industry Report.

The Emergence of the "Private IPO" and "Super Seed" Rounds

Notwithstanding hot public markets (at least before the late August correction), venture-backed companies are electing to remain private longer, which has resulted in historically large rounds of venture financing. PitchBook Data, Inc., et seq. Early-stage investment is also larger, which has started to blur the line between angel/seed and Series A. PitchBook Data, Inc., et seq.

Good times, bad times, you know I've had my share: Venture activity always lags strong public markets, and the 383 exits completed in 1H 2015 were 23 percent fewer compared with 1H 2014. Likewise, Q2 2015 had 173 exits, which was down 30 percent from the prior year. PitchBook Data, Inc., et seq. But, to be fair, it is still extremely difficult for startups to raise venture capital – it always has been, always will be and probably should be. Even more clear, while seed deals continue to rise, Series A rounds may be harder and harder to close. The increased flow of seed capital increases the risk that a larger number of startups will experience a "Series A squeeze" – more companies looking for a finite supply of institutional venture capital. That is, seed activity and late-stage rounds are less of a "crunch" and more an early-stage "squeeze" on Series A deals. PitchBook Data, Inc., et seq.

VC PLAYERS

Buyout Funds are Venturing Downstream ...

The old playbook for venture capital investing is being rewritten, due to the more diverse population of venture investors and beginning signs that VC-backed exits are declining. The allure of venture returns and low-cost technology company business models continue to attract private equity buyout funds. This is especially true in an environment characterized by longer-term investment bets, where more late-stage and buyout-oriented private equity funds see venture capital investments as growth-equity deals. We're seeing these funds place riskier bets on earlier-stage companies in the most popular sectors, including software, data security and healthcare IT, where capital requirements and hungry markets are hard to resist.

Private equity has always included venture, growth-equity and buyout funds, but the lines between these private equity players have become blurred. According to PitchBook, since 2008, 584 U.S.-based buyout firms have made at least one venture investment and 28 have been involved in at least 10 venture financings. In recent months, large funds such as KKR, Silver Lake and Warburg Pincus, and some smaller hybrid funds, have made venture bets. With valuations and round requirements reaching historically high levels, larger funds are needed to get deals closed. And there are rumors that the likes of Blackstone, Carlyle and KKR continue to look at acquiring venture capital firms. While migrating to venture can be a difficult investor sell for large buyout shops, middle and lower-middle market buyout and growth equity funds that have always preferred earlier-stage deals requiring less leverage have been well-positioned to get more exposure to technology and venture-backed companies. Financial Times, Smart Money, "Titans Turn Attention to Silicon Valley," March 9, 2015.

... And They're Getting Smaller

More lower and middle-market private equity funds are being raised, with the increase in the number of sub-$50 million, $100 million to $250 million, and $250 million to $500 million funds setting records for this decade. Arguably there is a value proposition for these funds: "Relatively small funds may have a higher risk than billion-dollar-plus vehicles, but that risk is offset by the smaller check size needed and the possibility of higher growth for smaller companies, which could translate into an overall higher return." PitchBook 2H 2015 U.S. PE & VC Fundraising & Capital Overhang Report, PitchBook Data, Inc. Venture capital is not just for startups anymore, and certainly more traditional private equity is not just for take privates. The distinction between "venture" and "private equity" today is driven more by industry-sector focus than asset-class consideration, and everyone seems anxious to get in on the technology company craze, even in the face of – or precisely because of – a certain eventual cooling of the public markets.

VC HUBS

The Urbanization of VC – Kudos to the Keystone State

We previously focused on the migration of venture capital activity from California to other U.S. regions. This migration has settled in New York and Boston, as well as many cities in between, including college and destination towns that highlight quality-of-life attributes. Indeed, companies in the Southeast followed only California and New England in Q2 2015 venture funding. This reflects the increasing desire of funds to ignore geography in their quest for solid investments. While venture capital funds likely will continue to concentrate in larger population centers, it is clear that funds continue to be willing to invest in promising companies in different time zones.

Pennsylvania's two largest cities provide a good case in point: MoneyTree reports that three of the most active venture investors in Q2 2015 reside in Philadelphia – First Round Capital, DreamIt Ventures, and Ben Franklin Technology Partners of Southeastern PA − and one is in Pittsburgh, Innovation Works, Inc. The remainder of this list is dominated by funds located in California, New York and Boston, and corporate VC. MoneyTree Report Q2 2015, PriceWaterhouseCoopers, National Venture Capital Association, Thomson Reuters. The overall focus may be close to home, but capital-hungry ventures are well-advised to broaden their geographical scope for funding.

VC VERTICALS

Software and SAAS Dominating VC

Software investment continues to outpace all sectors, increasing 30 percent from Q1 to Q2 2015 for a total of $7.3 billion invested, the largest quarterly investment in software since Q1 1995. MoneyTree Report Q2 2015, et seq. Software companies are leveraging the cloud by providing software-as-a-service (SaaS) solutions, versus the older software licensing and maintenance model. Software is a VC natural, with relatively low development costs, rapid scalability and seemingly infinite addressable business and consumer markets. Applications are endless, as businesses can cut IT support costs by outsourcing a variety of functions: Management, payroll, human resources, professional development, long-distance learning, legal compliance, collaboration, publishing and content management all lend themselves to a SaaS provider. Consumer demand is strong, as consumers want to shop, play games and conduct their financial lives over the Web. The activity in software has been encouraged by "the rapid drop in distributed computing costs, the expansion of SaaS and the rapid rate of mobile penetration." PitchBook Data, Inc., et seq.

VC TIPS

Protecting Your Good Name – Just Do It

Startups need to be vigilant about protecting names and other trademarks. "Established Firms Fight Startups on Names," Wall Street Journal, B5, June 11, 2015; "Travelers Doesn't Want to Share Its Umbrella – Insurer Rains on Others Over Logos," Wall Street Journal, A1, May 26, 2015. Even if there is low risk of claims, taking small steps to protect a company's name, logos and brand often pays off upon exit.

We appreciate the need for early-stage companies to manage legal fees and other costs, but name protection often finds itself in the penny-wise, pound-foolish bucket. We've seen promising emerging-growth companies get blindsided by a trademark claim or, more often, a venture or sale transaction frustrated by questions regarding intellectual property protection. Other IP questions often overshadow trademark protection, but protecting the company's name and logo can be addressed with early planning and a little vigilance.

Simply using a mark in the ordinary course of business creates some trademark protection, but these rights are limited. Registering the mark with the U.S. Patent and Trademark Office (USPTO) provides greater protection, including the following:

  • It affords exclusive protection for the trademark throughout the U.S.
  • It grants rights to bring an action in federal court.
  • It forms the basis to obtain registration in many foreign countries.
  • It allows filing with U.S. Customs to ban imports of infringing goods.

It is prudent to run a trademark search before filing a USPTO application. This prevents running into problems with competing marks that may already be registered. The USPTO registration process generally takes six months to a year, and sometimes longer. Hiring counsel and preparing a strong trademark application can reduce setbacks and allow for a smooth process.

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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