Widespread economic uncertainty and a tough exit environment saw venture capital (VC) investment fall 20% to $US41.5 billion and the number of rounds decline 8% to 4,970 in 2012, according to Ernst & Young’s Tenth Annual Venture Capital Insights and Trends report.
Average round size also decreased to US$8.4 million. Mirroring the trends in investment, the total number of VC funds closed down 13% to 280 from 323 in 2011 and the value closed down 31% at $29 billion.
Investments were down in all markets and the amount of financing in the seed and first round stages dropped across all regions. The US and Europe continued to dominate – accounting for 85% of global investment.
“2012 was a tough year for global venture capital and we saw consolidation in the market as the number of active investors declined," says says Maria Pinelli, Global Vice Chair, Strategic Growth Markets at Ernst & Young. "However, we are hopeful that 2013 will see the industry turn the corner. Steadying economic conditions will bolster investor confidence and point towards a strengthening risk appetite.”
Number of exits down
The number of VC-backed IPOs and M&A exits were down in 2012. The amount raised via IPO declined globally by 27% from $22.1 billion in 2011 to $16.1 billion in 2012. At the same time, VC-backed M&A activity declined by more than 20% to 618 deals.
“Speeding the time to exit will help VC funds return capital to their investors, show a successful track record and get them started on the process of opening, raising and closing new funds," says Pinelli. "IPOs are still the most lucrative exit vehicle and, as post-IPO performances are increasingly important, trends point towards VCs retaining a portion of their investment post-IPOs.”
VC model is realigning
VC funds are adjusting their investing strategies in favor of later stage companies.
Globally, the share of investment directed at revenue-generative companies increased to 69% in terms of the number of deals (from 56% pre crisis in 2006) and 74% in value terms. Angel investors stepped in to fill the gap in start-up stages left by VC.
“We see evidence of money flowing into companies that are perceived as less of a high-risk. There is a shift away from social media towards enterprise. Companies that are attracting greater VC interest are providing a service and getting paid for it.
This trend toward later and smaller investments in less risky companies is being accompanied by a move to tougher terms,” comments Pinelli.
Increasing role of corporate venture
Corporate venture investing is rising and surpassed pre-dotcom levels in 2012.
Corporates are keen to invest in and acquire venture-backed companies to fill the in the gaps in their strategy and innovation capability.
Corporate venture investments, which tend to be focused in the US on later stage businesses, generally have a positive impact. The valuation of the business in that round is typically greater than in companies at a similar stage with no corporate investor – the median valuation premium over the last decade has been 54% in the US.
In China, VC activity dropped from the record levels of 2011. In 2012, $3.7 billion was invested in 202 rounds, a year-on-year decrease of around 40% for both figures.
Despite this, the median value, at $10 million, was significantly higher than that in other parts of the world, due to substantial investments in profitable companies.
Beijing, one of the emerging hotbeds, attracted a significant amount of VC investment through relatively fewer deals.
At $19.9 million, the average round size in Beijing is the highest and well above the global average of $8.4 million.
“We expect the VC market to rebound in the second half of 2013. Although growth will be steady, we do not anticipate a return to the heights of recent years,” continues Pinelli.
India bucked the declining global trend in VC investment activity in 2012. The number of investment rounds increased by 17% to 205, the third successive year of increasing activity.
The growth of India’s investor community and the resulting increase in the amount of capital being invested in domestic opportunities provides India’s VC industry with a degree of insulation from global shocks, and the outlook for the coming year is positive.
“It’s worth remembering over half of today’s Fortune 500 were created in a downturn so not surprisingly competition for high quality deals is fierce," says Pinelli. "VCs are competing with each other and with other sources of capital. Establishing a robust VC value proposition for investee companies is a must-do strategy."
Ernst & Young expects 2013 to be a better year. "Early signs suggest better exit prospects – a pre-condition for increased fund-raising and a more supportive environment for the sector,” explains Pinelli.