Venture Capital Investment Trends: Paying More for Less

Analyzing Recent Venture Capital Trends

The current period is marked by a surge in data releases from prominent firms such as Silicon Valley Bank (SVB), CB Insights, PitchBook, and Crunchbase News. We are actively examining these datasets to gain valuable insights.

This week, The Exchange focused on the SVB “State of the Market” report for the fourth quarter. Like previous reports from the bank, it presents a comprehensive collection of charts and analyses, covering economic indicators, trade statistics, and venture capital data.

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Our review of this information revealed a notable trend. Venture capital investors are increasingly allocating larger sums of money to acquire smaller ownership stakes in startups that demonstrate lower profitability.

This observation isn’t intended as criticism. Rather, the intense competition for investment opportunities, the prevalence of round preemptions, escalating valuation levels for promising startups, and increased investments in growth-stage companies have collectively reshaped the venture capital landscape.

The resulting market dynamic is unlike any previously observed.

SVB has granted The Exchange permission to share select charts. The following graphical analysis of the data supports the assertion that venture capital investors are currently facing less favorable terms than usual, a conclusion based solely on the available data.

A Shift in Venture Capital Dynamics: Less for More

Initially, let's analyze the decreasing timeframes between startup funding rounds. Data from SVB reveals a clear difference between 2020 and 2021, with a comprehensive chart illustrating this trend over an extended period.

As demonstrated in both charts, venture capitalists are increasing the speed at which they make subsequent investments in startups. This acceleration is what was previously referenced as “faster” investment cycles.

However, deploying capital into startups more rapidly and in greater amounts isn’t without cost. Deal sizes are increasing over time, with the most significant growth occurring in later-stage funding rounds. The following graphic from SVB illustrates that the compounded growth rate of Series D rounds exceeds those of earlier stages.

This observation defines what was meant by VCs “paying more.” Another perspective on this increased investment is to examine the multiples, which SVB notes are also on the rise. For instance, late-stage multiples for enterprise software companies increased by 30% from 2020 to 2021.

Consequently, what are venture investors receiving in return for these larger rounds at higher multiples? A diminishing share of ownership!

However, it’s important to note that the companies receiving this funding are also experiencing increased losses. The following illustrates EBITDA trends across several startup sectors:

Investing more frequently and at higher valuations for a smaller stake in less profitable startups might appear disadvantageous. Yet, one crucial factor remains unaddressed: growth.

Increased investment in startup equity is justifiable if those startups demonstrate accelerated growth. For example, if startups collectively grew 50% faster, the observed trends would simply reflect increased valuations and market adjustments.

But is this accelerated growth actually occurring? To a degree, yes, but not to the extent previously suggested:

Interpreting this chart can be challenging. Focus on the dots moving upwards and to the right, indicating growth and profitability. A movement upwards and to the left suggests rapid growth at the expense of profitability. Here, all data points are trending upwards and to the left, not to the right.

Therefore, the rising losses are correlated with accelerating growth, although not as significantly as anticipated for enterprise software and consumer internet companies. The fastest-growing sectors – frontier tech and fintech – are also the least profitable, suggesting their growth is costly.

In conclusion, the trends observed in 2021, characterized by preemptive rounds and the inability of VCs to justify revenue multiples with future TAM calculations, are fundamentally altering the returns professional startup investors are realizing for their capital.

Currently, it represents a favorable environment for founders.