Jul 23, 2015 · 7 minutes

As venture capital valuations and deal sizes continue to soar, one thing is for sure: A decreasing amount of this “venture capital” is actually coming from venture capitalists.

Increasingly, the money that is really skewing these amounts higher and higher is coming from private equity funds, mutual funds, hedge funds, sovereign wealth funds, mega-Asian corporates… with just a dash (comparatively speaking) of Sand Hill Road tossed in.

If the doomsday scenarios of sky high burn rates prove true, at least we won’t have just VCs to blame this time around. We’ll have the entire global finance world. Save Wall Street--oddly enough-- which has been comparatively conservative in assessing and valuing tech companies.

It’s been said before but bears saying again: This is an age of the private IPO, and quite possibly the IPO downround.

The second quarter venture capital stats are starting to roll out, today KPMG has published theirs, produced in conjunction with Pando-fave, CB Insights. The top line numbers are bigger than last year’s – which is no surprise to people following the spate of near-daily mega deal press releases.

Here are some of the more heady stats:

  • Already “venture capitalists” have invested $60b in 2015, versus $88b for all of 2014.
  • Large deals are driving every funding trend in North America, Europe, and Asia. In the second quarter late stage deal sizes were $74 million on average. In Asia they were even bigger at $192 million.
  • Seed and Series A deal sizes grew too, averaging $4.7 million. Seems everyone is taking Josh Kopelman’s advice.
  • $100 million (or larger) rounds have increased dramatically this year. (Oh, hey, entire financial world!) So far, there have been over 100 mega rounds, 61 of which were closed in the second quarter for a combined $16 billion. $16 billion. That’s not much below what VCs would invest in an average year before things got nuts.
  • Valuations continue to increase too. In the second quarter, 24 new companies achieved $1 billion valuations, compared to just 9 the same quarter a year ago. That’s 35 new unicorns this year, for those keeping track.
  • How about exits? Not such good news there: There were only four exits larger than $1 billion in the second quarter.

I wrote two days ago about the horrifying decrease in capital efficiency throughout the now 100+ unicorn herd, and why it’s the single most worrying stat to me in the venture world.

These new stats just show again what’s driving it: Delayed IPOs, more cash at higher valuations, and a shrinking gap between valuation and cash raised. As Kopelman wrote to LPs: "We don’t have a crystal ball -- and we can’t forecast the future -- but we do have a calculator."

But I won’t belabor that point here. More interesting are two other questions. The first is: Was this the quarter that we reached peak mega-round? Some VCs have noted a slowing of these deals after Zenefits’ mega $500 million round, although CB Insights notes there have been a few that closed since.

In general, the pace of deals has been slowing. In the first quarter, the number of US deals fell to their lowest amount in two years. While there was an uptick in volume in the second quarter, on an annual basis the number of deals is still below 2014 levels, according to the survey.

How many more mega rounds are out there for the third quarter? Anand Sanwal of CB Insights says he hasn’t seen any sign of fewer mega deals in the data as of yet, but he notes that most of the companies who were due to raise a mega round seem to have already closed it. Sure, there are companies like Uber who seem to raise $1 billion before they get out of bed in the morning. But most of the multiple mega-rounds are happening outside the United States. As this report notes, only Uber has raised multiple $500 million rounds in the US.

So, if the third quarter is going to see an increased escalation in mega deals something would have to structurally change… again. That’s not impossible. Consider either of these scenarios:

  • Asian deals hitting a whole new level of mega, pushed by the Asian corporate giants like Alibaba, Tencent, Baidu and Softbank. Indeed, there doesn’t seem to be a slow down at all here. And in the second quarter, Asian deals were on average bigger than US deals.
  • Unicorns getting substantially more aggressive about capital raised. That would be remarkable given that the cash in unicorn coffers has already increased more than 100% year-on-year with each on average having raised half a billion. As Aileen Lee wrote last weekend, even in a time of insanely high valuations for these companies, the valuation vs. private capital raised for these companies is a mere 8x. Given the struggle for these companies to go public at an upround as is, it’s hard to imagine another step function up in capital raised after we’ve just seen more than 100% increase in cash raised by unicorns.

That said, given so many of these rounds are not being driven by actual venture capitalists, it’s hard to know exactly what psychology is driving all of this. If mega rounds decrease this quarter it won’t be a demand problem, it’ll be a supply problem.

How did we get here? It all goes back to the dot com bubble. (I hope in another decade I can stop writing that sentence.) That was the era when the venture capital business went from boutique cottage corner of the finance world to full-blown asset class. As more and more Americans put their retirements into 401(k)s and wealth grew around the world generally, more money wanted to come into “alternative assets” of which venture capital became a sexy one with the dawn of the Internet. We went from $30 million fund sizes to $400 million fund sizes to $1 billion fund sizes in rapid succession.

After the bubble burst, many firms clamped down on the size of their funds -- either through choice because they wanted to force some sanity back into the industry, or because they didn’t have the track record to support a mega-fund any longer. It’s not how much money you manage in venture capital that matters-- unless you are just working for management fees, in which case, you’re a pretty shitty VC. Rather it’s how much you can reasonably invest and return a multiple of capital on. To operate $1 billion fund you need to be pretty sure you can make enough bets to yield companies worth many, many billions of dollars. In the wake of the dot com bust, a $300 million fund looked like a much easier hurdle to clear.

But here’s the thing: Back then any decrease in the number of firms or size of their funds was almost entirely self-inflicted damage within the VC industry. The huge and growing community of limited partners showed no sign of wanting to pump even more capital into the industry. This was partly because investors believed the downturn would be cyclical and partially because so many new global LPs came online who needed to diversify assets. The amount of money these huge financial institutions were putting into venture capital was comparatively tiny for them-- yet in aggregate it was huge for the venture industry, which has to invest a few million bucks at a time. So even in the downturn, it was still worth the risk.

As firms like Sequoia decreased their fund size, those LPs still had to put that money somewhere. And that’s why mediocre firms didn’t die as many expected them to in the years after the dot com bubble. 

That brings us to today. Big firms have started to raise mega-funds again, excited by the playbook Yuri Milner charted out when he did Facebook’s mega-round in 2009. But that still didn’t create enough room for all the LPs out there. And it was becoming clear to many that investing in zombie VC firms wasn’t a great alternative if you couldn’t get into one of the top funds.

So instead, all these other would-be LPs just started to do what Milner did: Investing directly themselves. If the VCs wouldn’t take their cash, they’d just co-invest with them side-by-side. Hedge funds and mutual funds had little other choice if they wanted to play in the high-growth game because companies were going public so much later and a lot of the value was being created while they were still private.

This trend has only been exacerbated recently. Low interest rates have put even more pressure on all this mega-money to find places where they can get better returns. And given the gargantuan growth in international money coming out of emerging markets, it’s hard to see the trend stopping.

Only one problem: There’s only so fast companies can be created that justify $500 million capital rounds -- even by today’s inflated logic.