Demand for Venture Capital Outstripping the Supply
Fewer entrepreneurs expect to be able to tap traditional venture capital funds in 2014, but corporate venture money may help fill the gap.
As talk of a tech bubble spreads, a handful of tech stocks have pulled back in recent weeks. While signals are definitely mixed, the broader innovation economy remains on a roll, at least according to Silicon Valley Bank’s recently released Innovation Economy Outlook study.
Highlights of the survey of 1,200 global technology and life science executives (and entrepreneurs) include the following:
- 65 percent of respondents say their company met or beat 2013 revenue targets, the highest rate in five years.
- 82 percent think 2014 will be better than 2013, the highest level of optimism reported in five years.
- The median expected growth rate of respondent’s companies in 2014 is 30 percent.
- 76 percent of the companies plan to hire in 2014.
That’s all great news. But if you are the CFO of a company seeking to raise capital, it is worth drilling down deeper, as the positive growth data does not tell the whole story.
Innovation economy companies by definition are about developing the next-generation product, service or marketplace, and it takes scale to generate the financial returns and disruptive breakthroughs to stay relevant and thrive. To achieve that scale, companies face a pair of consistent limiting factors: securing access to adequate capital and finding and keeping workers with the right skills.
Access to equity financing is one of the top three challenges executives identify for 2014 (the other two are scaling operations and recruiting employees/managing talent). I’d like to focus on access to capital, and why raising capital remains challenging for many, despite the fact, according to industry reports, that an impressive $9.5 billion in venture capital money was invested in U.S. startups during the first quarter of 2014 — the highest quarterly total since 2001.
While traditional venture capital remains a key source of startup funding, there are trends limiting availability to the masses. Two trends are the continued geographic and economic concentrations of capital, and large funds focusing on “home-runs” with mega rounds to a smaller number of later-stage winners. Furthermore, since 2008, venture funds on average have been investing unsustainably more (on the order of $6 billion to $10 billion annually) than they have been raising.
Against this backdrop, we are witnessing increasing velocity in new company creation. Yet, the number of total funded venture capital deals has remained relatively flat at 900 to 1,000 per quarter for 10 years, and even in light of increasing capital efficiency by these companies, there aren’t enough VC dollars to meet the demand. Consequently, these high-growth companies must look to other sources of innovation capital to fill the void.
While traditional venture funds remain the most sought-after, corporate venture investors are becoming increasingly important financial and strategic partners. Corporate venturing had been an exclusive club of high-profile technology companies like Google and Intel, but now it is quickly spreading to mainstream enterprise companies such as GE, Comcast and automakers that want to stay ahead of the technology curve.
The Innovation Economy survey shows that entrepreneurs are already feeling the impact of the shift in funding: Among U.S. executives planning to raise funds, 43 percent say they expect to receive venture capital, down from 48 percent who successfully tapped that source in 2013. Forty-one percent of executives raised angel funds in 2013, but only 23 percent expect to in 2014. (This steep decline likely reflects the natural shift of maturing companies seeking larger investors.) In private equity, while 20 percent raised capital from that source in 2013, just 14 percent expect to in 2014.
Interestingly, despite the 2012 enactment of legislation to encourage crowdfunding, only 2 percent of companies (3 percent of pre-revenue companies) raised capital via this method. The uncertain regulatory landscape may very well be limiting crowdfunding activity.
The funding expectations reverse when it comes to corporate venture investments; just 9 percent of executives reported receiving corporate venture money in 2013, but 16 percent expect to raise money from these funds in the future. Fearing they may miss the next wave of technology, large corporations are investing in essentially “outsourced R&D” to gain a view of what’s coming (half of investments were seed and series A in the first quarter of 2014, according to CB Insights) and to be positioned to move quickly and more aggressively should a product or service fit strategically.
This alternate source of innovation capital are catching up to venture capital when it comes to funding U.S. startups, and we believe it will eventually eclipse VCs in funding activity. According to CB Insights, $7 billion was invested globally by corporates in the first quarter of 2014.
As the Innovation Economy Outlook reveals, even in this period of accelerated growth and pervasive optimism, securing equity capital remains a top challenge for innovation entrepreneurs. Here are three quick tips that can help relieve the anxiety around capital-raising:
- First and foremost, focus on building the absolute best product, platform or service, and the funds will find you.
- Second, relative capital efficiency has improved 10 to 100 times in the last 10 years, so a company can bootstrap longer (even to the point where the first revenue is generated) or choose to fail fast and iterate with muted damage.
- Third, manage your relationship network like the lifeline that it is, so that capital providers know you and your company well before capital is needed.
(By Scott Bergquist, a senior market manager for Silicon Valley Bank, overseeing business development and client relationships. He specializes in financing solutions for high-growth technology and life-science companies).
Source: cfo
