Venture capital confidence is plummeting, hits two year low

The slow IPO market and the proliferation of extremely high valuations is making VCs skittish

By all accounts, things are going well for venture capitalists right now. Funds are raising more than they have in years and the VCs are investing more than they have in years as well. Yet, something is wrong. VCs are not happy. 

On a scale of 1 to 5, with 5 indicating the highest level or confidence and 1 indicating the lowest level of confidence, VCs registered a 3.73, according to the The Silicon Valley Venture Capitalist Confidence Index for the second quarter of 2015, released on Tuesday.

That is down from 3.81 last quarter, and is actually the lowest point in two years. So, yeah, that's not good.

So what exactly is happening here? Why are VCs losing confidence in the market? The report tries to come up with multiple explanations for the downturns. 

Part of it may have been the low IPO turnout of the beginning of the year. With 34 IPOs raising $5.4 billion, the first quarter of 2015 turned out to be the least active quarter by IPO count since the first quarter of 2013, and the smallest by proceeds raised since the third quarter of 2011. To compare: the first quarter of 2014 saw 64 deals, and $10.6 billion raised. The only major tech IPO of the first quarter was cloud storage company Box. 

Things picked up quite a bit in the second quarter of the year, though, going up 83 percent in volume and 111 percent in proceeds raised, compared to the first quarter of 2015, according to PwC. There were 75 IPOs completed in the second quarter of 2015 which raised more than $13 billion.

“After a surprisingly slow start, the IPO market for venture-backed tech companies has begun to accelerate. I think 2015 will finish strong and carry over in 2016," Sandy Miller of Institutional Venture Partners said in a statement.

Others thing it may have had to do with concern over sky-high valuations, or so-called "unicorn fever." In 2014 alone, 38 different companies entered the $1 billion club. That is more than the three previous years, when only 22 companies made it combined. That included Kabam, Tango, Eventbrite, and JustFab. 

Amazingly, this year is already on track to surpass that number, by far, according to a new report out from CB Insights. In just the first four months of this year, 16 companies have already reached unicorn status.

In March alone seven companies raised money at billion-dollar valuations. If the number holds, there will be 50 new billion dollar companies by the end of this year.

“While an expectation of a continued strong exit market – both initial public offerings (IPO) and mergers and acquisitions (M&A) – for venture-backed firms remained, along with an abiding confidence in the Silicon Valley ecosystem for new venture creation, increasing concern about high valuations of venture-baked firms restrained sentiment,” said Mark Cannice, professor of entrepreneurship and innovation at USF, who conducts the research study, which has been done for the last 46 consecutive quarters.

Actually, the two problems might be tied to each other. Sky high valuations are actually allowing companies to put off going public because of so-called "private IPOs," which basically means that companies are able to stay solvent longer thanks to big fundraising from mutual funds, hedge funds, private equity investors and sovereign funds. It's a term that was coined by Josh Kopelman of First Round Capital earlier this year.

Kopelman warned of the danger of letting these companies stay private longer than they should. 

"I don’t think we’ll fully understand or appreciate the impact of the 'private IPO' phenomenon for another decade, or at least until a full cycle plays out," he wrote in a blog post. "In my opinion, there isn’t nearly enough focus on 'low frequency trading.' Public companies reprice daily. Private companies don’t have to reprice for years on end."

That makes it easy to see why VCs might be getting somewhat nervous about their investments. Of course, the next question is: what does all of this actually mean for the future of venture capital, in both the short term and the long term? 

The answer seems to be that, in the long run, everything will be fine. In the short-term, though, there could be trouble. 

“While the powerful ecosystem in Silicon Valley for venture creation, innovation, and long-term value creation continues to grow stronger, short to medium-term prospects for positive investment results appear somewhat less certain," said Cannice.

“The perfect storm of mobile, social and cloud still remains strong and augers well for the health of the tech eco-system long-term,” Venky Ganesan of Menlo Ventures said in a statement. “Both seed-stage and late-stage venture is experiencing frothiness as the tourists have arrived and they are paying prices that the locals won’t. I expect a correction in the near term especially when the Fed raises interest rates, but the long-term picture remains very strong.”

(Image source: theinvestorzone.com)