VCs prepare for ongoing tight exit market

By September 15, 2009Venture Capital

If a company’s exit expectations decline it must raise less money to generate the same returns for its VCs.  Less money means smaller rounds and less space for syndicate partners.  Venture Source data in the graph below (courtesy of WSJ) which shows a dramatic increase in the percentage of first investment rounds with only one VC is therefore an indication (I would say strong indication) that in aggregate the venture industry is projecting that the exit market will remain weak for some time to come.

According to the WSJ similar trends are in evidence for later rounds as well.

There are, of course, a number of other factors which add to this trend, not least the fact that as the number of VCs reduces it has become harder to find syndicate partners, but my hunch is that the exit climate is the primary driver.

Overall I think this means that smaller rounds and less syndication are likely to remain features of the market for the next couple of years.  This in turn puts a higher premium on capital efficiency than at times when exits are higher and the ‘land grab’ strategy pays more dividends.

 

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  • frosty_ash

    Surely syndication was also, if not only, a means to providing the higher funding requirements driven by higher valuations in periods of prosperous market growth? VC's entering by themselves should capture higher returns as their shareholding would not be diluted. Even though the exit market now appears to be unattractive it will not (cannot) last forever. As VC funding is essentially a long term investment, its times like these in which VCs should actually be investing more as the market for exits later should be better. Or am I wrong?

  • It depends on how quickly you think exits will bounce back. VCs typically hope to exit in around three years in the knowledge there is a good chance it will take a little longer. I'm not sure I would want to bet on exit valuations increasing in three years, and this data suggests many others feel the same.

  • cedricL

    If the exit horizon is further away a company needs to raise more cash…not sure that the VC returns are what entrepreneurs care of in the first place, they're here to build successful businesses. But having this in mind, that’s VCs who are looking for capital efficient companies to maintain their returns.
    + if you think that the exit is not for tomorrow you’d probably tend to try to syndicate with deep pocket investors early on to avoid funding risk along the way.
    A possible explanation of “a dramatic increase in the percentage of first investment rounds with only one VC” might be that there aren’t many VCs who are doing early stage investments these days (would be interesting to see how many times the same VCs have been reported doing early stage deals/concentration of early stage VC investors).
    This being said I agree with your conclusion.
    C.

  • frosty_ash

    Surely syndication was also, if not only, a means to providing the higher funding requirements driven by higher valuations in periods of prosperous market growth? VC's entering by themselves should capture higher returns as their shareholding would not be diluted. Even though the exit market now appears to be unattractive it will not (cannot) last forever. As VC funding is essentially a long term investment, its times like these in which VCs should actually be investing more as the market for exits later should be better. Or am I wrong?

  • It depends on how quickly you think exits will bounce back. VCs typically hope to exit in around three years in the knowledge there is a good chance it will take a little longer. I'm not sure I would want to bet on exit valuations increasing in three years, and this data suggests many others feel the same.

  • cedricL

    If the exit horizon is further away a company needs to raise more cash…not sure that the VC returns are what entrepreneurs care of in the first place, they're here to build successful businesses. But having this in mind, that’s VCs who are looking for capital efficient companies to maintain their returns.
    + if you think that the exit is not for tomorrow you’d probably tend to try to syndicate with deep pocket investors early on to avoid funding risk along the way.
    A possible explanation of “a dramatic increase in the percentage of first investment rounds with only one VC” might be that there aren’t many VCs who are doing early stage investments these days (would be interesting to see how many times the same VCs have been reported doing early stage deals/concentration of early stage VC investors).
    This being said I agree with your conclusion.
    C.