United States: Q2 2018 Quarterly VC Update: Stephen Kraus On The State Of Venture Capital Investing

Last Updated: September 7 2018
Article by Josh Rottner

In conjunction with our Q2 Venture Financing Report, I sat down with Stephen Kraus from Bessemer Venture Partners to get his take on the state of venture capital investing.

A few highlights from Stephen Kraus

On deal terms: Generally, the terms have been company and entrepreneur favorable for a long time now, and they continue to remain that way.

On the proliferation of late-stage investors: It's created this downward movement on stage of financing, and therefore upward pressure on what a normal Seed or Series A round looks like.

On Bessemer's response to the influx of capital: We're doing a lot more earlier-stage investing. The key to moving earlier is to know when to double down on your winners.

On fewer IPOs: There's a lot more talk about companies staying private, and I don't necessarily think that's a bad thing ... by definition if you have more time to mature, you should be more predictable and stable in your growth profile and earnings potential, which is generally more attractive to public market investors over the long term.

The key takeaway from our data is that the number of deals and amounts being raised are just going through the roof – which is interesting given that we all have thought that the threshold couldn't get any higher than it has been over the past few years. We'd love to hear your thoughts on this macro environment. Does your experience match our data or is it inconsistent with what you're seeing in the market?

I am not surprised by the data. It feels like we're at "peak froth" in the market, which I don't necessarily see changing, simply because I think venture capital, in some ways, has a lot of latency in the market, and what I mean by this is that obviously, the broader public equity and financial markets, as well as the broader economy are all performing pretty well. During times like this, I think you tend to see venture capital firms use the peak nature of the market to raise more and larger funds, and that has definitely been happening. General partners are raising larger funds and deploying those funds in shorter cycles and shorter fund lives. Where funds used to raise every four years, you now see funds going out to raise every two years.

There's also a perfect storm of capital to continue to chase, with more companies being formed and a lot more capital chasing high-quality entrepreneurs. You see this in the data – valuations, especially for the mature companies that are performing well, continue to rise. And as the valuations rise, the round sizes rise. It's definitely a frothy time out there.

It seems like entrepreneurship, specifically entrepreneurship in the high-growth space and venture capital-backed entrepreneurship, is having a bit of a social moment now, as exemplified by TV shows like HBO's "Silicon Valley." I remember when I was going through school everyone wanted to be a banker, and now everybody wants to be a startup entrepreneur.Do you feel like that is driving this cycle? Could it be that there is so much capital chasing these opportunities that this is becoming a more viable plan for folks? Do you have any other thoughts on the macro societal trends there?

I think there's certainly a macro trend in in our society where you've got a "rise above" millennial generation that doesn't adhere to the standard life/career/business mores. The concept where you first need to go get a job where you learn skills and then you advance up the corporate ladder – that's all gone. I think the idea of being able to work for yourself as an entrepreneur is becoming more and more appealing. This is a generation who grew up with technology in every aspect of their life – they're mobile native, technology native. So, it's not surprising that you have more people wanting to chase entrepreneurship.

I do agree with the capital chasing theory, by the way – I went to Harvard Business School and I always say that whatever the graduating HBS class wants to do, you should just short that market. When I graduated in 2008, it was real estate. Well, it turned out that was a bad industry going in at that time, but now, I think you see the majority of HBS class graduates wanting to be entrepreneurs. This is partly driven by the type of graduate that's entering the market, undergrad or graduate school, paired with it being a great time to be an entrepreneur. It's relatively easy to raise capital now as compared to the market 10 years ago. So there are two factors – the broader societal factor and the market constraints, or lack thereof, in terms of capital chasing.

How are you feeling about deal terms? Are the terms more company favorable in light of increased capital chasing investment opportunities?

I think deal terms have been company favorable for five to seven years now, and I haven't seen any change. When I looked through your data, the most interesting change I saw was an uptick in pay-to-plays, and I'm deducing you've got crazy, high-priced rounds for relatively early stage companies, and that you get a lot of late-stage capital flooding into the early stage market. So, if you're going to pay a high price, put a lot of capital in and prop up the ownership of the early stage investors by definition, then maybe the way to give yourself some sense of protection is to have a form of pay-to-play provision. That said, I actually haven't seen a lot of pay-to-plays in my deals. Generally, the terms have been company and entrepreneur favorable for a long time now, and they continue to remain that way.

The only other phenomenon that I've noticed shining through in your data is valuations increasing. Yes, on the later-stage deals, but even on the earlier-stage deals. I think it has a lot to do with the fact that there's a lot of capital in the market – it's an entrepreneur-favorable market, and valuations tend to creep up.

Obviously, there's been the "SoftBank effect," but they're a unique case unto themselves. I've also seen private equity firms such as the General Atlantic, Carlyle, Warburg and Summit Partners of the world – those who tended to do buyouts or later-stage growth investing – starting to move even earlier, which for them means doing a Series C or D-type round. However, investing in highly unprofitable companies in those rounds has not been their modus operandi in the past. This means there are PE groups coming into these C and D-type rounds – a trend that's causing the folks that used to do C and D-type rounds, like the IVP's or the TCV's of the world, to move into the Series B rounds, the investors that used to do the B-type rounds to move into the Series A rounds, and the A guys to move to Seed. It's a downward movement on stage of financing, and therefore upward pressure on what a normal Series Seed or Series A round looks like. You see that in your data, and I absolutely see that in the market place more than anything else – it's like, holy cow, those guys used to do buyouts, now they're looking at my highly unprofitable software company. This is the strangest stance going on, and I think it's happening in these markets because of the chase – people are looking for "value" anywhere they can find it.

How does that trend impact your thoughts on how to attack the market as an investor?

We move earlier. Bessemer has the ability to invest across stages – anywhere from $100 thousand to $100 million check size, we're able to write. But, we're doing a lot more earlier-stage investing. So we tend to move earlier in times like these.

You guys just kicked off a specialized seed-stage fund. Is this a reaction to that phenomenon?

In some ways, yes. For example, we've got this healthcare artificial intelligence/machine learning seed fund and, even for those companies, it's still very early days in terms of those technologies being applied to healthcare. I think we've seen maybe 200 companies that serve broadly in that space and that maybe five are over $5 million in revenue. So, the majority are either total startup or sub a few hundred thousand dollars of revenue. And the ones that actually do have a little bit of traction in that space, say north of $1 million dollars, they're raising really large Series A or Series B rounds, but they're still very early in their maturity curve. We thus found ourselves getting priced out of those rounds. Given that it's a relatively early market, our strategy is to make a bunch of seed investments across a number of great entrepreneurs and technologies and then follow those companies over time. This strategy is a reaction to what we are seeing in the market, for sure.

Is that affecting what you expect on returns, or is that still the same blueprint?

I wouldn't speak for Bessemer here, but I generally think this vintage of venture is going to be a challenge as a whole asset class in terms of the overall return on invested capital. By definition, it kind of has to be... it's just math – more money chasing after the relatively same number of deals at a higher price. That equation should mean lower returns for the overall vintage and asset class.

For us, we moved earlier, for sure, but when you look at our historical performance, early stage deals are where we get the outlier skew effect that drives venture capital funds. The key to moving earlier is to know when to double-down on your winners and decipher where there's a signal that a company's actually got breakaway growth or breakaway product market fit. And then, for those companies where you have an early stage position, really double-down on those winners – that's the key to the model. With a big fund, we need to be able to do this. We've shown the ability to do this with some of our best companies like Shopify, Twilio, Yelp and Pinterest, where we did the Series A but then we invested significantly in the follow-up rounds, and I think that that's the important part about making that model work.

Do you have any predictions on exits – either on IPOs or M&A? Given how much is invested in the early stage, what's your sense of how those are doing and implications for trends going forward?

I would say the word "bubble" is thrown around. I said "peak froth" earlier, but the truth of the matter is that it's a different sort of bubble than the 2000s bubble. I think the glass half-full scenario is that these companies are raising unicorn-type rounds and getting hundreds of millions of invested capital from SoftBank and other later-stage investors of the world. While those private equity firms may be moving earlier, these companies are still real companies. They've got real products that meet a real customer need. They've got real unit economics that work. They're scaling quickly, and many of them have software-like margins so that, even if you stop investing in the growth and start focusing on profitability, you can get these companies into profitability in a relatively short period of time because the underlying gross margins are attractive.

So, essentially, what these late-stage investors are allowing these companies to do is take a longer time to develop before they hit the public market, and you see that in the data. There are just by far fewer IPOs. There's a lot more talk about companies staying private, and I don't necessarily think that's a bad thing because, by definition, if you have more time to mature, you should be more predictable and stable in your growth profile and earnings potential, which is generally more attractive to public market investors over the long term.

Sure, you can hit an IPO window and have a nice pop and good first-quarter earnings, but the truth is that any experienced CEO who has been in the public market before will tell you it's not about the first quarter, it's not even about the IPO price, it's about the eight quarters after you go public. I think these companies that are staying private longer should allow for more predictable companies to enter into the public market. That's the positive side.

The negative side is obviously that there's less liquidity. At least in the IPO sense, there's less than I think some people would have hoped in the near-to-short term. At Bessemer, we have had a number of really special IPOs and a bunch of M&A, so we've been able to yield attractive returns, but I think in the broader market, you've obviously seen stories written and concerns about whether these companies are staying private too long.

I don't worry too much about that because, to put it in another way, there have been a lot of unicorns and if I could buy the entire basket of unicorns out there, I would. Not every single one will be a winner, and yes, there will be some colossal wipeouts, but as a basket of companies, they are a really good set of private companies and I'd love to be a shareholder in an index of unicorns. I think that index is going to do well. The question is, what's the timeframe? Is it the next couple of years? Is it the next five years or 10 years? It's going to be a good basket of companies once they enter the public market.

Given that healthcare's universe of buyers is a little bit more limited, and liquidity via the capital markets is a much more tried-and-true path, do you find any split between healthcare and tech in your outlook?

The biotech IPO market has been on fire for five years now. Frankly, strategic M&A in biotech has been the second-class option for exits because the public markets have been so liquid for biotech companies. Ten years ago, strategic M&A used to be your #1 exit option for biotech, and now it's definitely IPO.

I don't think the buyer universe is actually that small. There are a number of healthy and strong-balance-sheet pharma and biotech, large and medium sized, that could be buyers. I just think they're currently having a hard time competing against the public markets.

And, for the companies that are still earlier in the growth phase (because they're in pre-clinical or early clinical development), they want to be able to access public markets to help push for the development of their products – versus selling now at what would presumably be a discount given that there are clinical and regulatory risks. I think most biotech entrepreneurs would rather access the public markets and have the capital to play out the experiment, if you will.

And in your area of focus on technology in the healthcare space – are you seeing more of the traditional Silicon Valley-style tech exit?

Yes, there's been a lot of capital poured in the healthcare IT and services space. While still not as robust as the biotech market, there have been some strong IPOs like Teladoc and Evolent Health. I think the M&A universe is pretty large there, though, and so you've seen, for example, Flatiron Health exit to Roche, PillPack exit to Amazon and Optum and United Healthcare be very strategically active. You've got a whole set of payers and a whole set of traditional healthcare IT companies. With some of the traditional tech companies like Amazon, Google and Apple getting into the space, I think there is a large set of strategic buyers in that universe.

About Stephen Kraus

Stephen Kraus is partner at Bessemer Venture Partners and leads the firm's healthcare investing activities. He currently sits on the boards of Welltok, Bright Health, Groups, Qventus, Health Essentials, Docent Health, Alcresta and TScan, and is a board observer at Collective Medical Technologies. Steve has been recognized by Forbes Magazine as one of the top healthcare investors in the industry. He co-hosts the podcast "A Healthy Dose" and often blogs about his views on the healthcare industry.

About Bessemer Venture Partners

Bessemer Venture Partners (BVP) is a $4.5B global venture capital firm that invests in consumer, enterprise and healthcare startups from seven offices around the world. One of the longest standing venture capital firms in the world, Bessemer invested in the early stages of Pinterest, Twitch, Bright Health and Skype and has helped 122 of its companies go public, including SendGrid, Twilio, MindBody, Shopify, Wix, Yelp and LinkedIn.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions