VCs can't rely on old friends as first-half exits decline

Venture capitalists haven't faced an exit environment as challenging as they've seen this year since the start of the decade. Through the first half of 2017, VCs are on pace to sell the fewest number of portfolio companies in seven years. Yet at the high end of the market, the exits have never been bigger, driving the total value of exits to a near-record level. Only five venture-backed companies have ever sold for $3bn or more and two of those deals – AppDynamics and Chewy – printed this year.

Not only are the differing trajectories of deal volume and value an anomaly, the acquirers are as well. The largest tech giants that in years past have outsourced much of their R&D to Sand Hill Road have stepped back from the market. In their place have come a new set of buyers – mainly private equity (PE) firms, but also shoppers from outside the tech ecosystem. While those buyers can deliver the kinds of blockbuster returns that make a VC fund, their needs are distinct from those of a traditional tech acquirer and that could impact how new and follow-on investments are evaluated.

Through the first half of the year, the dollar value of sales of venture-backed companies sits abnormally high at $16.2bn. According to 451 Research's M&A KnowledgeBase, that's 19% higher than the same period last year and the highest value of VC portfolio acquisitions in the first half of any year since 2002, with the exception of 2014 (the year Facebook shelled out $19bn for WhatsApp, which stands as the biggest acquisition of a venture-backed company by a factor of five). The number of sales from VC portfolios, however, sits at 285, the slowest first half since the start of 2010, a year that saw about half of the deal value on roughly the same number of transactions.

As the second quarter came to an end, the decline in deal volume accelerated. Only 33 venture-backed companies were sold in June, the least of any month in the past eight years. Moreover, since 2012, VCs experienced at least four months each year where they sold more than 60 companies. This year, the highest monthly total is 56. Yet the eight exits valued at $500m or above puts them barely short of last year's record total – 17.

Private equity's venture

The bulging coffers of buyout funds are delivering a record amount of exits to VCs, providing some measure of relief as strategic acquirers scale back dealmaking and the IPO market remains a selective venue. Although to some degree, the speed at which those buyers are moving has helped elbow out other would-be strategic acquirers.

PE shops and their portfolio companies spent $5.3bn on 44 venture-backed startups in the first half. That's more than they spent on such companies in all of last year and sets them up to deliver a record number of VC exits by the end of the year.

Returns from both PE firms and strategic acquirers range from prodigious to paltry, although usually at vastly different multiples at the high end of the market. With more involvement in the VC market, the median multiple paid by PE shops to buy companies out of venture portfolios lines up with the 3.8x trailing revenue on all sales of venture-backed companies. But where strategic acquirers are often pushed by fear of competition or the potential for synergies to pay outlandish multiples, PE firms are more inclined to couple the price tag to the target's financial performance and therefore rarely pay the kind of multiples that, for example, Cisco paid in its two largest deals this year (17.4x for AppDynamics and 24.4x for Viptela).

Enterprise technology exits

Sales of enterprise technology companies from venture portfolios have been a bit easier than consumer tech. Business tech hit a four-year high in deal value at $11.8bn. Like the broader market, volume dropped a bit to 203 transactions, compared with 237 during the same period last year.

Cisco's continuing transformation into a software vendor pushed it to become the largest acquirer of startups with the purchases of AppDynamics ($3.7bn), Viptela ($610m) and MindMeld ($125m). Two other IT infrastructure giants delivered more than $500m in venture exits as they transition into new markets. CA Technologies nabbed Veracode for $614m as it pushes into DevOps and Hewlett Packard Enterprise knocked SimpliVity down from its unicorn status with a $650m purchase to expand in hyperconverged storage.

Absent from the market for VC-backed enterprise tech were the largest software providers. Aside from Oracle, which handed over $650m (plus a $200m earnout) for ad measurement specialist Moat, none of them bought any venture startups worth more than $100m. Last year, Salesforce and IBM each snagged multiple companies out of VC portfolios in deals valued above that mark, while Microsoft and Oracle picked up one each.

Filling in the gap of enterprise tech exits were non-tech companies (medical distributor McKesson reached for its largest VC-funded target with the $1.1bn acquisition of pharmaceutical software maker CoverMyMeds), newly public vendors (Atlassian, Castlight Health and Snap each spent $100m-plus) and, oddly, a special-purpose acquisition vehicle that took Rimini Street public in a reverse merger, marking the first time such a deal has delivered VCs an exit worth more than $250m.

Consumer tech exits

Exit activity for consumer tech startups carries with it the same dynamic of rising deal values amid declining volume. According to the M&A KnowledgeBase, venture investors sold just 82 consumer tech providers worth $4.4bn in disclosed and estimated value. The total deal value marks the largest first half total since 2014; transaction volume, however, continues a four-year decline in consumer tech exits from a first-half peak of 118 in 2013.

That decline continues despite seemingly ideal conditions for consumer tech M&A. The most frequent historic acquirers of these companies – internet giants such as Facebook and Google – have experienced outsized gains in stock price this year, above and beyond the broader market.

Despite that environment, Google, the most active acquirer of venture-backed startups over the previous four years, inked just three such deals this year (of five total transactions). Facebook hasn't done a single one, while Yahoo sat on the sidelines for the 18 months leading up to its just-closed sale to Verizon. Apple and Amazon have been in the market, although neither has printed a deal for more than $250m since 2015.

Buyers of consumer tech showed the most appetite for venture-backed e-commerce providers, although those companies, as they did last year, were scooped up by PE firms and players coming from outside tech. BC Partners-backed PetSmart delivered the largest consumer tech exit to VCs with the acquisition of Chewy for an estimated $3.35bn, while Wal-Mart followed last year's multibillion-dollar reach for with a pair of smaller e-commerce purchases – Moosejaw ($51m) and Bonobos ($310m).

Intra-VC pairings

Sales of venture-backed companies to their peers took a dramatic hit this year. Through the first half, only 64 VC-funded startups sold to their compatriots, which is down from 102 such pairings during the same period a year ago and sets up 2017 to be the first year in the past 10 when the number of these deals has substantially dipped.

These transactions rarely mark an exit for the investors in the acquired company, yet they often provide a struggling business with improved exit prospects – $1.4bn worth of venture money got a second chance last year, compared with just $92m so far this year. More importantly, these deals serve as a proxy for the overall health of the VC market. Although there is the occasional distressed pairing, most of these acquisitions happen when the buyer feels some degree of optimism.

Take Singular's acquisition of Apsalar, a mobile analytics specialist that found itself outmatched by competitors with more funding and deeper product suites. In that recent deal, the acquirer was bolstered by a $15m series A it raised in June. Yet many companies in the venture cycle face greater uncertainty, both about the shrinking paths to exit and the availability of future funding – Wall Street remains as selective as ever about new offerings, while many of the crossover investors that helped fuel a rise in startup valuations – e.g., BlackRock, Fidelity Investments and T. Rowe Price – have stepped back from the market.


The shift toward more financially minded buyers of VC-backed companies should have investors tying valuations to financial performance at earlier stages. And founders themselves should be pushing for this, although it could lead to greater dilution in their companies. High valuations often get in the way of otherwise valuable businesses making money for founders or even finding a buyer, as we discussed in a recent report on potential M&A in ad tech.

The venture capital model incents investors to spread their bets to find the few companies that will have a $1bn-plus exit, at which point lofty valuations in early rounds are of little consequence. But entrepreneurs are locked into a single bet. According to the M&A KnowledgeBase, the median exit price for a venture-backed company over the past four years is $68m – enough to generate a life-changing amount of money for many founders, but not if that doesn't get them over the cap table.

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