The only thing certain about the global economy is uncertainty. Thanks to political unrest, terrorist attacks, and the repercussions of Brexit, caution is the dominant mindset of investors in every market, according to the latest quarterly global report on venture capital trends published jointly by KPMG International and CB Insights.
This is the fourth consecutive quarter where investors pulled back despite a total $27.4 billion invested across 1,886 deals—seven of which were in the $1 billion unicorn range. After a high at this time last year, the total number of deals declined an additional 6% from the first quarter of 2016.
Although the percentage may appear incremental, startup and earlystage company growth are important to the global economy. Unemployment, wage growth, and productivity, among other factors, are driven by entrepreneurial activity. And that doesn’t happen without funding.
"It’s a challenging time for VC investors," said Brian Hughes, a partner for KPMG in the U.S. "Many investors are holding back to see how these uncertainties shake out, while others are focusing on companies they see as having a solid foundation and growth plan—like Uber, Snapchat, and Didi Chuxing," Hughes said in a statement.
Those three are"decacorns": private investor-backed companies with a market valuation of greater than $10 billion. The North American market had only one new VC-backed unicorn earlier this year, however, five new unicorns debuted this quarter including Human Longevity, Zoox, and SMS Assist. That collectively helped boost funding figures in North America, where they rose 10% to $17.1 billion, even though deal activity in the region was down 8%. The region still leads the global VC landscape in terms of activity.
Anand Sanwal, CEO of CB Insights, said, "Unless you’re one of five companies for which there is insatiable investor appetite, it is becoming tougher to raise money from VCs." He believes more companies will be focusing on profitability and taking on cost-cutting measures in the coming quarters.
On the whole, that means investors are focusing on late-stage, more established companies. This may be because going public could offer them a profitable exit. However, IPOs aren’t always lucrative. The report found that of the 10 largest IPOs in 2015, around two thirds are trading below their offering price.
"The challenge for VC-backed companies, especially large unicorn companies like Uber and Airbnb, will be the pressure to eventually go public," the report states. That’s because as their valuations increase, an IPO becomes the only viable exit option.
The report indicates that when unicorn deals are taken out of the equation, deal count is down to 1,117, its lowest since early 2012. The report also found that funding for seed rounds was also down from 33% in 2015 to 28% in this quarter.
VC firms that made the most deals were New Enterprise Associates, Khosla Ventures, Accel Partners, General Catalyst Partners, and Google Ventures. Thirty-four percent of venture capital investors are based in California and 612 deals were made in the state in this quarter. New York City had 134 deals and Massachusetts had 58 deals. In contrast, Canada’s top tech cities (Montreal, Vancouver, and Toronto) brought in 36 deals total.
Internet companies took 50% of deal share for the first time in five quarters, while health care and mobile saw decreased deal share in the second quarter of 2016, according to the report. Software only saw 5% of deals, and consumer products was down to 3%.
Drilling down further, Slack, Zoox (self-driving vehicles), and Human Longevity’s genomics health tech service raised $200 million or more in funding rounds.
As for the best performing investments, the report found that when comparing sectors, artificial intelligence is gaining ground in 2016. "The relative strength of AI investment can likely be attributed to its broad-reaching applications, with investors across industries and regions interested in finding ways to utilize AI to create or enhance business offerings or to extend a company’s customer reach," the report states. It predicts that companies developing AI, cognitive computing, and robotics will continue to attract VC investment even amid economic uncertainty and potential regulatory issues.
Another trend that emerged is how investors are becoming much more involved with their companies. Arik Speier, head of technology at KPMG in Israel, explains that they want to ensure the money they put in will help sustain and grow the business. However, he says, "Investors also seem to be much more vocal with their opinions on the business models of companies and the identified short- and long-term goals."
Mihir Jobalia, managing director of Corporate Finance at KPMG in the U.S., says that in North America there’s been an increase in investor activism among many large corporations. "Investors are demanding these companies use their money or give it back to shareholders," he explains. "This is driving a significant amount of merger and acquisition activity as companies sitting on a lot of cash look for ways to put their capital to work," says Jobalia.
Anand Sanwal of CB Insights observes:
"While the deal levels look poor especially relative to the ebullience we saw in Q3 2015, if you look at this quarter’s numbers against a longer timeframe, we’re still at very healthy funding and deal levels. In other words, the sky is not falling but the forecast is definitely uncertain. One piece of good news we are seeing is the consistency of corporations. They were the first investors many expected to cut and run should times get tough. It looks like they’re continuing to stay committed, which is a good thing for startups and their investors."