Global venture capital investments in early stage startups drops again

01 June 2016

A shot of reality has befallen the venture capital backed startup market, as it seems investor sentiment is seeking certainties over possibilities. The total number of deals and the value of investments into early stage startups has dropped to the lowest point in two years, reflecting the growing concerns from investors. The changing fortunes within the venture capital scene are however likely to just be a short blip, as the pursuit for returns, on the back of abundant dry powder, continues.

Venture Capital backing is a key funding source for a range of startups seeking to become the next unicorn with their own innovative or differentiated offering. For venture capitalists, the sometimes high risk ventures provide a means to book serious returns on their capital investment. In recent years the startup environment has taken off – a recent report shows that venture capital funding globally jumped from $44 billion in 2012 to $128 billion last year. The heating of the market follows a number of trends, including the rise of digital technologies that have the potential to disrupt markets and the growing demand from venture capitalists seeking lucrative returns. Corporates too are playing a role – they are showing growing interest in, at an early stage, capturing the innovative potential of what may otherwise become, the competition, a movement also known as corporate venturing.

In a new report, KPMG and CB Insights look into the most recent developments in the venture capital (VC) market. The research looks at equity funding that enters emerging companies from venture capital firms, corporate venture groups or super angel investors. The study is based on verified funding from a range of federal and state regulatory filings, direct sources (i.e. investors or startups) and data from analyst agencies.

Venture capital investment in startups

Changing sentiment
Interest in investing in startups has grown considerably over the past three years as both the number of deals as well as their respective total value rose to new heights midway through 2015. At its peak, a total of $39 billion was invested in one quarter. The end of last year saw a drop off, particularly in the number of deals, which fell by almost 200 on the previous quarter, while total investment dropped to $27.7 billion. The fall reflected concern within the investment community about the true valuation of their investments, prompting hesitation. As such, much more focus is now being placed on companies that demonstrate revenue creation, positive margins, the ability to control expenses, and profitability – or a realistic path to achieve it. In some industries, investors might also evaluate other performance metrics – like customer retention, bookings or operating margin.

The negative sentiment has persisted into the first quarter of 2016, with deal volume as well as deal value falling further, to 1,829 and $25.5 billion respectively. The drop reflects a deterioration in the mega-deal market, as well as continued considerations surrounding overvaluation. “VC investors are becoming more cautious and more skeptical,” says Arik Speier, Head of Technology at KPMG in Israel. “In order for companies to attract funding – especially at the seed stage – they will need to have a stronger business plan, positive margins and a way to prove the validity of any bullish projections.”

Venture capital investment in startups by region

In terms of changes within the three key markets, North America has seen the largest fall in deal value and deal volume since Q3 2015, on the back of concerns about valuation, interest rate increases and the presidential election. Deal volume has remained relatively stable over the past two quarters, at 1,112 and 1,101 respectively. Deal value has ticked up slightly in the US, from $14.3 billion in Q4 2015 to $15.2 billion in Q1 of this year.

Asia and Europe have seen a much less sharp decline in deal volume over the past year, from 403 to 358 in Asia and from 355 to 338 in Europe. Deal value in Asia saw rapid gains during 2015, almost tripling from Q1 to Q3, before falling back to close to Q1 2015 levels by Q1 2016, at $6.5 billion. European deal value has remained stable, at around $3.5 billion across the year.

Venture capital investment per startup typeThe research also found that the types of funding available is shifting up the maturity ladder. Investors are considerably less keen to fund Seed/Angle level startups in Q1 2016 than a year previous, falling from 35% to 28% respectively. Series A funding has gained a boost, taking in 26% of the pie in Q1 2016 compared to 22% in Q1 2015. In the same period, series B funding increased ever so slightly, while ‘other’ funding types increased 2% to 18% of the total share.

Corporate Venturing in startups

Corporate innovation
The research highlights that while a number of venture capital investor types are shying away from investments, corporates are becoming increasingly active. A recent study from Arthur D. Little finds that corporates and startups are becoming increasingly close, as corporates seek to leverage the innovation potential of startups to be the first to disrupt, or transform, their own business environment. One of the modes of collaboration is through corporate deal participation into VC-backed companies. The level of participation increased to 27%, representing a 5-quarter high. Asian corporates are particularly keen to engage with startups, 32% of deals there involving corporations or corporate venture capital groups.

Anand Sanwal, CEO of CB Insights, comments: “Corporations continue to look to access innovation by engaging in corporate venture investments. A flood of new corporate VCs and existing corporate VCs becoming more active, coupled with large corporate balance sheets, suggests that the influence of corporate venture arms will grow over time.”

VC-backed companies entering the unicorn club

The research further explored the landscape to identify the number of unicorns that had come into existence within the various quarters over the past year. Unicorn creation has fallen significantly, from a peak of 25 in Q2 and Q3 2015 to 5 in Q1 2016. The creation of a unicorn is, at the best of times, difficult enough; recently unicorns have been battling negative press, as well as seeing their valuation slashed, including the likes of Square, which saw its valuation halved from $6 billion in 2014, and 58 other tech start-ups suffered “down rounds” since the start of 2015.

Future trends
The changing fortunes within the venture capital back market are likely to just be a short blip, according to the KPMG analysts. The global market still contains considerable ‘dry powder’, some of which will be hunting for unicorns. One change however, may be that rather than focusing on horses that show possibility for unicorn transformation, more focus will be on their performance. Brian Hughes, a Partner with KPMG in the US, remarks: “Overall concerns around the global economy and a decline in valuations in most parts of the world are leading investors to be far more selective than in the past. VC investors are increasingly rolling up their sleeves and looking for performance rather than possibility.”


8 tips for successfully buying or selling a distressed business

18 April 2019

Embarking on the sale of a business is one of the most challenging experiences a management team can undertake. Even serial dealmakers acknowledge that the transaction process can be gruelling, exposing management to a level of scrutiny and challenge through due diligence that can be distinctly uncomfortable.

So, to embark on a sale process when a business is in distress is twice as challenging. While management is urgently trying to keep the business afloat, they are simultaneously required to prepare it for scrutiny by potential acquirers. Tim Wainwright, an experienced Transactions Partner with Eight Advisory, says that this dual requirement means sellers of distressed businesses must focus on presenting their business in a way that supports buyers in identifying value, whilst simultaneously being open about the causes of distress. 

According to Wainwright, sellers of distressed businesses should focus on eight key aspects to ensure they are as well prepared as possible:

  • Cash: In a distressed situation cash truly is king. Accurate forecasting and day-by-day cash balances are often required to ensure any buyer is confident that scarce cash reserves are under proper control. 
  • Equity story and turnaround plan: Any buyer is going to want to understand the proposed turnaround strategy: how is the business going to enact its recovery and what value can be created that means the distressed business is worth saving? Clear presentation of this strategy is essential.
  • The business model: Clear demonstration of how the business model generates cash is required, with analysis that shows how financial performance will respond to key changes – whether these are positive improvements (e.g., increases in revenue) or emerging risks that further damage the business.  Demonstrating the business is resilient enough to cope with these changes can go a long way to assuring investors there is a viable future.
  • Management team: As outlined above, this is a challenging process. The management team are in it together and need to be consistent in presenting the turnaround. Above all, the team needs to be open about the underlying causes that resulted in the distressed situation arising.  A defensive management team who fail to acknowledge root causes of distress are unlikely to resolve the situation.

8 tips for successfully buying or selling a distressed business

  • Financing: More than in any traditional transaction, distressed businesses need to understand the impact on working capital. The distressed situation frequently results in costs rising as credit insurance becomes more difficult to obtain or as customers and suppliers reduce credit. Understanding how these unwind will be important to the potential investors.
  • Employees: Any restructuring programme can be difficult for employees. Maintaining open communications and respecting the need for consultation is the basic requirement. In successful turnarounds, employees are often deeply engaged in designing and developing solutions. Demonstrating a supportive, flexible employee base can often support the sale process.
  • Structuring: Understanding how to structure the business for the proposed acquisition can add significant value. Where possible, asset sales may be preferred, enabling buyers to move forward with limited liabilities. However, impacts on customers, employees and other stakeholders need to be considered.
  • Off balance sheet assets: In the course of selling a distressed business, additional attention is often given to communicating the value of items that may not be fully valued in the financial statements. Brands, intellectual property and historic tax losses are all examples of items that may be of significant value to a purchaser. Highlighting these aspects can make an acquisition more appealing.

“These eight focus areas can help to sell a distressed business and are important in reaching a successful outcome, but it should be noted that it will remain a challenging process,” Wainwright explains. 

With recent studies indicating that the valuation of distressed business is trending north. With increased appetite from buyers who are accustomed to taking on these situations, it is likely that more distressed deals will be seen in the coming months. “Preparing management teams as best as possible for delivering these will be key to ensuring these businesses can pass on to new owners who can hopefully drive the restructuring required to see these succeed,” Wainwright added.