Startup investments drop on valuation concerns, corporate venturing rises

Venture capital investment has down tracked across 2016, as investors became more wary about investing in angle/seed startups. While total volume decreased by more than 5,000 deals to 13,600, total value has remained high, at $127 billion. Capital pumped into corporate venturing continues to ride high, growing to $65 billion last year, as companies seek external inspiration.

Uncertainty has reigned across the venture capital (VC) market over previous quarters as investors became increasingly critical of portfolio companies and targets in terms of their long-term value creation potential. In KPMG’s latest ‘Venture Pulse Report', in association with market research analyst CB Insights, which covers the final quarter of 2016, the firm explores whether the trend that began the year, also finished it. 

Total venture activity

The research found that VC related activity has slowed down considerably across 2016, with total investments closed down from almost 18,000 in 2015 to more than 13,660 deals last year. The volume of deals has fallen to levels last seen in 2012 when there were just over 13,000 deals. Deal value however, remain considerably above 2012 levels, at $127 billion.

The drop over 2016, particularly in volume, reflects continued investor caution around valuation following, among others, poor IPO exit results at the start of the year. In 2015 caution was, in part, thrown out the window as investors leveraged cheap dry powder to invest in a range of companies, thereby avoiding ‘missing the boat’, by investing in almost anything that may spring legs. Startups too have reacted to the change in atmosphere, in part, by reducing their capital burn.

“2016 was a reality check for the venture capital market,” comments Brian Hughes, one of the leaders of KPMG's Venture Capital Practice in the US. “Investors drew back considerably. They paused, re-evaluated and focused on their existing portfolios and gave greater scrutiny to deploying new money to both new and existing investments.”

The research shows a considerable decreased in investment volume in the angel/seed stage companies, with investments falling from around 2,500 in Q1 2015 to around 1,300 in Q4 2016. The decline has been relatively steady over the intervening quarters, with levels in the most recent quarter last seen at the end of 2012. Early stage VC funding has slowed down in the most recent quarters, but considerably less than the angel/seed stage. Late stage VC funding, while dipping ever so slightly in volume, has remained relatively stable.

The research also sought to gauge which segments of the wider startup landscape have been the most successful in attracting VC funding. In terms of value, software companies have steadily increased their share of the overall pie over the past seven years. During 2016 around 50% of the total share $127 billion went to the segment, down from 38% the two years previous and just over 20% in 2010 – maga deals to companies like Uber underpinned the trend. Consumer goods & recreation has seen the biggest decrease in the total pie – although that pie has increased considerably in size in absolute terms. Energy remains a key draw card in terms of value, while IT hardware and media have both been hit by investor disinterest.

In terms of volume however, a different picture arises – with stability largely holding between 2010 and 2016. Software companies increased their share of the pie by around 10%, but far lower than the value discrepancy. Pharma and biotech remained relatively stable, as did consumer goods & recreation. Media however, took a hit, as did IT hardware – however, deal volumes increased considerably between period.

The authors in addition traceded the geographical distribution of deal activity for the most recent period. The results show that particularly Americas based investors, have become edgy and reduced their investment activities. The region has seen steady growth since the financial crisis, before hitting a plateau between 2014 and 2015. 2016 saw a sharp decline, falling from around 11,000 deals to around 8,600. Europe too has seen a period of steady grow fall into decline, with deal volumes falling from just over 4,000 to around 3,000.

One area that has continued to see steady growth is the phenomenon of corporate VC activity in the wider VC market. Corporates are increasingly looking to acquire innovation through strategic investments in third parties. Investments gives them access to entrepreneurial talent, that can freely operate in a different culture, while opening up mutually beneficial opportunities for both parties.

The study finds that this kind of investment has increased from around 11% of total VC activity in 2010 to 15% in 2016. Total value has however, skyrocketed, increasing from $12 billion to around $65 billion.

Going into 2017, Arik Speier, Head of Technology at KPMG's arm in Israel remarks, "Investors will likely remain cautious heading into 2017. They have made tremendous efforts to raise funds while interest rates are low, but they'll likely play it smart with investments. We likely won’t see the floodgates open until the IPO market opens up and we see what the valuations are."