Eye-popping is the only word that comes close to describing the numbers we saw this year from venture finance. The valuations accelerated rapidly, with companies like Slack jumping past the billion dollar mark in less than a year of the launch of its enterprise social product. Google announced a massive $542 million round in Magic Leap in October, and just yesterday, Instacart announced that it had reached a valuation of $2 billion following a round led by Kleiner Perkins.
Even if these valuations were frightening, we could at least find solace in the equally eye-popping acquisition prices technology companies were willing to spend this year on high-flying startups. The year started with a bang following Facebook’s announcement of its $19 billion acquisition of WhatsApp, in what remains the highest price ever paid for a startup.
The major acquisitions never stopped either, with Facebook also purchasing Oculus, Google buying Nest Labs, and Apple obtaining Beats all in multi-billion dollar transactions. In the enterprise space, massive acquisitions were equally the norm, with SAP buying Concur in a $8.3 billion transaction, and Oracle buying Micros at $5.3 billion.
There remain lingering concerns about whether we are seeing the start of a whole new era of startup growth or the final throes of an ecosystem completely out-of-control and about to pop. That bubble question is entirely the wrong one to ask though, and that is why 2015 is going to be the most interesting year in venture capital.
To see just the start of this, take a look at Beepi, which announced that it added another $12 million in capital to its previous $60 million round. While extending a round is not uncommon, what made this round so interesting was one of the sources of those funds. AngelList, the online fundraising site, put in $2.7 million led by Gil Penchina’s syndicate, the largest investment ever made from the platform.
This is truly a new world for VCs. While AngelList’s presence has certainly not gone unnoticed in the venture world, its effect has been most immediately felt by angels themselves in seed rounds. Until now, the platform’s round sizes were simply not at a scale where early-stage investors had to spend much time considering the platform or how they might fight it competitively.
That is changing as its rounds increasingly move into the seven-digits. Many firms thrive on investments at a couple of million dollars a piece, and now these funds won’t just compete with each other, but also with every large syndicate on AngelList. That is great news to entrepreneurs, who will almost certainly gain better valuations and more control over their company, but for traditional VCs, they are going to have to find ways to adapt against this new onslaught of funding.
Even more than the early-stage changes though, growth rounds of fast-growing companies are increasingly going to be done by insiders, or more specifically, friends of the insiders. Venture capitalists are increasingly offering their limited partners the ability to invest directly into later rounds of their early-stage investments, giving them important exposure to growth while mitigating management fees. LPs have traditionally eschewed these sorts of options, preferring to back investment managers who can make these decisions on their behalf. But as startups increasingly wait to exit, the investment options for growth are simply more limited.
If I had to make a single prediction about venture capital in 2015, it is that the gulf between the very top venture capital firms and the rest of the industry will widen even more than it is today. Top firms who can organize these sorts of easy growth rounds can promise almost unlimited capital to their entrepreneurs, eliminating the bane of fundraising for founders. That’s a heck of a selling point when the term sheets come in.
While this has obvious implications for founders, the wider implications are for everyday investors. Since the 1990s, common investors have been increasingly prevented from investing in growth stocks since startups simply don’t go public as early as they used to. These issues will only compound as large managed funds increasingly become comfortable with investing directly in growth rounds. A founder will almost certainly prefer to take dollars from a handful of private investors rather than submitting to the vagaries of the stock market. That investment inequality is going to accelerate rapidly in the coming year as the tools and contracts needed to manage this capital mature.
The other issue, which Eric Kim and Chi-Hua Chien brought up in an article here recently, is that tech companies are sitting on a pile of cash, about $600 billion or so. These changes to later growth rounds also means that the returns that tech companies can potentially receive from their cash will decline if they aren’t actively investing that money in strategic growth rounds. Google’s half-billion investment into Magic Leap is just the beginning of this phenomenon.
2015 is shaping up to be one of the most interesting years for venture capital ever. We will witness the rewriting of the rules for early-stage fundraising as well as a change in the mix of capital for growth rounds that will spread out the growth of top companies far wider than before. Top Silicon Valley companies will continue to impress their incumbency status on the industry as well. While perhaps more of the same we have already started to see these past few years, 2015 will likely be the watershed year that all of these trends come together for the venture capital industry.