Is this just one more way in which venture capitalists are different from the rest of the startup world?
For the past year or so, there have been clear signs that startup investment is slowing. Several high-profile unicorns have had their valuations dinged by their late-stage investors. The dreaded down round -- even upon an IPO -- is becoming more common. And third-quarter data from CB Insights showed a precipitous drop in venture investment -- from $38.7 billion in the second quarter of 2015 to $27.2 billion just 90 days later.
And then what happens in the first quarter of 2016? According to preliminary data from Dow Jones VentureSource, reported in the Wall Street Journal, venture capital firms their best fundraising quarter since 2000, raising $13 billion. Some of the best-known firms, such as Founders Fund and Accel managed to raise billion-dollar-plus funds, again, in a market that is supposedly cooling.
That should be comforting for entrepreneurs who have been worried about their ability to raise capital. It probably won't do much to help later-stage companies that have largely relied on mutual funds and other non-traditional private company investors to postpone their initial public offerings.
To figure out what's going on here, it helps to remember that for most of the recent past, despite all the gloss and glamour associated with them, venture funds haven't necessarily provided returns any better the S&P 500. As recently as the end of 2012, the 10-year return for venture capital funds was just 6.9 percent, compared to 7.1 percent for the S&P 500, according to investment advisors Cambridge Associates.
That means pension funds, insurance companies, endowments and the like were putting their money into venture funds, and essentially locking up that cash for ten years, without getting the returns that ought to accompany such risks.
That's changed, and rather dramatically. The 10-year return for venture capital has recently risen to 11 percent, according to Cambridge Associates, compared to 6.8 percent for the S&P 500.
Strong returns make the VCs' job of raising money much easier, even if some of the best-known unicorns have stumbled. Most of the Silicon Valley VCs can credibly claim that they are not the ones pouring tons of money into late-stage deals, and that by investing at earlier stages, they can still make nice returns even if valuations take a hit.
The flip side of this may be that entrepreneurs' worries about being unable to raise venture capital for the foreseeable future may be somewhat overblown. All that money raised by the VCs has to be put to work, after all, and the way VCs do that is to invest in entrepreneurs and their companies.
For early-stage companies, and possibly for some VCs, these big funds postpone the day of reckoning. The fundraising environment for startups is likely to be better than anticipated, and the venture firms themselves get to collect management fees on all that money.
For later-stage companies, things are still going to be pretty messy. The availability of large late-stage financings, for hundreds of millions of dollars, is still going to shrink. It's just these financings that have stood in for initial public offerings, giving companies the ability to avoid a public market that's pretty much at a standstill. In the first quarter of 2016, according to Renaissance Capital, the IPO market hit a nadir not seen since the financial crisis of 2008, without a single deal priced outside of the healthcare sector.
Without the ability to raise those mammoth late-stage rounds that have enabled companies to postpone IPOs, entrepreneurs are going to have to get to exit much faster. It's no accident that "unit economics" has suddenly become a buzzword among VCs and at business plan competitions and entrepreneurship events. Getting big fast might be a great strategy when there is a seemingly unending stream of investors willing and able to finance that growth.
Without those investors, getting to profitability, or at least becoming cash-flow positive, becomes much more of a priority -- something every bootstrapped entrepreneur already knows.