United States: Venture Capital Coast To Coast – December 2015

Last Updated: December 9 2015
Article by Richard S. Grant and Steven J. Keeler

VC WATCH

2015 on Pace for Big Year Despite 3rd Quarter Cooldown

VC investment slowed in Q3 2015, yet 2015 is still on track to be one of the best years in several decades. "Venture Capital Cools in Third Quarter," http://www.cnbc.com/2015/10/15/pwc-venture-capital-declines-from-record-high-levels.html (citing report by PricewaterhouseCoopers, The National Venture Capital Association and Thomson Reuters) . Later-stage investments took a larger share of funding, up 10 percent despite the 5 percent drop in funding across all stages. Major stock market averages were down about 7 percent in the third quarter. This, coupled with some 141 startups with "unicorn" valuations ($1B+ level), may be causing some investor jitters. And, of course, there is the nagging concern that IPO and strategic exits are becoming harder to come by after previous quarters with strong public market and acquisition activity.

Despite the predictable "bubble" talk and a large amount of money to be invested, 2015 has already exceeded 2014. But much of 2015's success can be attributed to large "mega-rounds" (those exceeding $100 million), which have increased 125 percent over 2014. With valuations high and more money flowing into companies than being harvested through exits, we may be seeing the end to a hot cycle for VC.

David and Goliath: Early-Stage is Tough Business

A robust VC market does not always mean easy times for startups in search of capital. As always, VC investment lags public market and exit activity declines, and most VC downturns impact early-stage investing first. Seed-stage and angel investments have dropped for the fourth consecutive quarter (now making up just 28 percent of VC fundraising). The dominant VC funds have shifted to mid- and later-stage deals. And the size of early-stage rounds continues to increase, resulting in fewer, larger deals being won by a select few startups. "Where $98 billion in VC funding is going," http://money.cnn.com/2015/10/14/technology/cb-insights-venture-capital (citing a CB Insights and KPMG report) . Software continues to dominate VC fundraising, but health IT and fintech have enjoyed several recent mega-rounds. Large addressable markets for innovation always attract investors, and the healthcare and financial sectors offer seemingly infinite growth.

VC PLAYERS

Hedge Funds and VC: Masters of What Universe (or Odd Bedfellows)?

We have previously commented on the increasingly diverse universe of VC investors, from super angels and family offices to endowments and corporate VC arms. Even 401(k) managers like Fidelity, Wellington and BlackRock entered the VC scene in 2014. Hedge funds also could not resist the allure of direct investments in early-stage companies as the VC market set records in 2014. While hedge fund professionals are in a unique position to spot early-stage company opportunities, as contrasted with experienced VC fund partners, they are not necessarily astute VC investors nor able to monitor these investments. VC investing is much different from hedge fund investing: Hedge funds invest primarily in publicly traded stocks, bonds, derivatives and commodities, while VC funds provide capital to grow companies. And hedge fund investments are generally liquid, while VC investments often are long-term opportunities. VCs earn management fees and "carry" based on a "hurdle rate" concept, while hedge fund managers charge fees based on net asset values and a "high watermark" concept. So hedge fund success with VC investing will likely require that they hire VC talent to manage their investments.

Dallas-based Maverick Capital followed the lead of other prominent hedge funds when it raised a $500 million VC fund in early 2014. "Hedge Funds Add to Venture-Capital Bounty," http://www.wsj.com/articles/hedge-funds-add-to-venture-capital-bounty-1414021436 . Tiger Global Management had already shifted most of its business from managing hedge funds to venture capital funds, and Coatue Management and Valiant Capital Management had also become active in VC. As contrasted with opportunistic direct investments in the occasional unicorn, raising a separate VC fund can allow a hedge fund to hire experienced VC talent to properly manage VC investments. And while hedge funds usually make money by being stock market contrarians, they are definitely following the crowd when it comes to VC investment. Maverick's VC fund is focused on software and healthcare, two of the hottest VC sectors throughout the most recent VC heyday.

So is the Wall Street creep into VC a short-term phenomenon and how will it impact the VC industry? We hear many VC funds say that, to compete with these big players, they will look to invest earlier in companies to gain a foothold. Many believe that hedge-fund-sponsored VC funds will eventually start shying away from the later-stage companies due to concerns over inflated valuations. It remains to be seen whether they will fill in the increasing gap in early- and mid-stage funding, as that might require a certain expertise not typically associated with hedge fund investments. And are hedge funds good investment partners for a startup? Some entrepreneurs view VC funds as better and more patient long-term partners and fear that hedge funds will prove to be less loyal, "fair-weather" friends. One thing is clear: Hedge funds and other Wall Street investors have played a significant role in VC's 2014 and 2015 success and, perhaps, in the huge valuations that now have investors considering a more conservative posture.

VC HUBS

Oh Atlanta!

In July 2015, we read a post by VC fund Mosley Ventures titled "Atlanta Hailed as Silicon Valley of the South." www.mosleyventures.com/new/atlanta-hailed-as-silicon-valley-of-the-south. There may very well be a case for designating Atlanta as the new "Valley." In addition to being the headquarters for major corporations in many industries, including computing, sports, media and travel − think Turner (CNN), Coca Cola, Equifax, SunTrust, First Data and Delta − Atlanta has an exceptional talent pool of engineers. And it has fostered an "entrepreneur-first" culture, thanks to the Atlanta Tech Village, its affiliate the Atlanta Ventures Accelerator, and their local backers, Atlanta Ventures and Buckhead Investment Partners. Not to mention the difference one man can make – namely Sig Mosley, the founder of Atlanta-based VC fund Mosley Ventures.

Thanks to Atlanta's formidable VC community, including Georgia Tech ("Stanford of the Southeast"), First Data, Moseley Ventures and D.C.-based Kinetic Ventures (which also has an Atlanta office), Georgia has a significant number of companies in the information security industry. And it appears that much of the local money is invested at home in Atlanta. Mosley is focused on early-stage startups in Atlanta and the Southeast. It invests in security software, mobility and wireless, big data and healthcare IT. Like the household names of VC investing in the Silicon Valley, Moseley and Kinetic understand that data and communications will continue to be the focus of innovation in every industry. And Atlanta has proven itself a worthy location for any technology or software company.

Atlanta is undeniably a major metropolitan and cultural center in the U.S. Its good climate and relatively low cost of living combine with an entrepreneurial and "hip" subculture, which attracts the occasional immigrant from California or Boston. And, increasingly, Valley, Boston and New York-based, top-tier funds are investing in Atlanta startups. While Atlanta will have to compete hard with Silicon Valley, Boston and New York for a robust supply of angel and second-tier VC investors, Atlanta could very well continue to grow into a robust and active VC community.

VC VERTICALS

Cybersecurity and Big Data: The New VC Darlings

As lawyers, we witness firsthand the enormous demand from businesses and institutions to manage data privacy. CB Insights reports that over $7 billion has been invested in cybersecurity in the last five years, with the biggest year-over-year increase occurring in 2014. "Cybersecurity Financing and M&A Trends," www.cbinsights.com. Recent cybersecurity IPOs have included Palo Alto Networks, FireEye (backed by Sequoia Capital and Norwest Venture Partners), and NQ Mobile, and SAFENet, Trusteer and AirWatch (backed by Insight Venture Partners and Accel partners) were among some of the successful M&A exits. Google, McAfee, Symantec, Cisco Systems and IBM top the list of strategic buyers of cybersecurity companies, with Microsoft and Intel not far behind. And the top 10 VC investors have followed suit.

Cybersecurity provider (and now unicorn) Tanimum Inc. raised $120 million in Q3 2015 in funding led by TPG Growth, due in no small part to increasing media attention surrounding data breaches. Andressen Horowitz had led Tanimum's 2014 and early 2015 rounds. http://www.law360.com/privateequity/articles/698324?nl_pk . In July 2015, Google Capital led a $100 million round for CrowdStrike Inc.

Data "mining" or analytics solutions companies are also attracting VC. So far in 2015, cloud-based business management platform provider Domo raised $200 million in Series D from BlackRock and others, and Sumo Logic, a data analytics platform provider, raised $80 million in Series E from a club of investors including DFJ Growth, Greylock Partners, Sequoia Capital and Accel Partners. Other "big data" startups raising money in 2015 include MarkLogic, Banjo, Snowflake Computing, Saama Technologies and Guavus. Big data exits have included MasterCard's purchase of cloud-based analytics provider Applied Predictive Technologies, Microsoft's acquisition of mobile business intelligence provider Datazen, and Twitter's purchase of machine learning startup Whetlab. Newer data solutions companies Lyra Health, Maana and Massive Analytic have each raised seed or Series A rounds in 2015. And these are only a handful of the newest data analytics and management companies receiving significant venture investment or experiencing significant exits in 2014 or 2015. "What's the Big Data – Big Data Startups," http://whatsthebigdata.com/big-data-startups/. We expect growth in this sector to continue, given the growing importance of cybersecurity and big data solutions to numerous other industries.

VC TIPS

Protect Your IP: Simple, Cost-Effective Tips for Early-Stage Companies

Many early-stage companies do a terrific job at seeing the big picture: Founders have an excellent vision for the enterprise, know what needs to be done long-term to execute on their business plan, and are vigilant in courting investors and understanding the market for capital. But sometimes small but important details can get lost in the shuffle. One of these details is intellectual property. In the early stages of a company's life, IP can seem insignificant, yet IP ownership can be critical to the life of a company over the long term.

Patents, trademarks and copyrights are the lifeblood of many startups. Patent protection is the most complex and, as a result, will be the subject of a future post. But trademarks and copyrights − words, symbols, logos and the like (trademarks) and computer software and other creative expression (copyright) − can be just as important. We offer a few simple tips that every startup should follow. None of these require significant financial investment, although failing to take these precautions can be costly down the road.

  • All employees should sign "work for hire" agreements in order to ensure that all their work product belongs to the company.
  • Arrangements with consultants should also be documented to reflect that their work product is being created for the company's benefit and is owned solely by the company. We've seen many situations where third parties are engaged to consult on software development, without an appropriate agreement in place to ensure that the company is the sole owner and beneficiary of the work product.
  • Employees and consultants should sign confidentiality agreements. Although these agreements do not necessarily provide trademark or copyright protection, they can ensure that company secrets are protected from disclosure to competitors, and make employees think twice about taking valuable information to a competitor.
  • A company's name and brand can be critically important to its value. Each company should strongly consider engaging an expert to undertake a trademark search of its name and analyzing any potential conflicts with existing companies.
  • Along with trademark searches, companies should consider the value of protecting trademarks through formal federal trademark registration.

These are simple, cost-effective steps that all early-stage companies can easily follow, and VCs and other investors will appreciate and value the diligence and attention to detail.

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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