2018: Blockbuster Year for Venture Capital Deals, but Risks Lie Ahead

Blog
February 19, 2019

2018 was a blockbuster year for venture capital (VC) investments in terms of deal volume, deal value, and growth. According to the Pitchbook Data Q4 2018 Venture Monitor quarterly update report[1], VC investment in the United States exceeded $130 billion in 2018, the highest on record. It was also significantly higher than the 2017 VC investment of $83 billion. Excluding Altria Group’s mega-investment of $12.8 billion in JUUL Labs in December, 2018 deal value would be approximately $118 billion, which represents 42 percent year-over-year growth. The last time growth in deal value in the VC space exceeded 40 percent was 2014, when growth was almost 50 percent. Despite equity market volatility, Q4 2018 deal value was in line with Q1 through Q3 after excluding the JUUL Labs investment.

From an industry perspective, investments in software companies again led the way in 2018. 42 percent of VC deal volume and 40 percent of deal value was attributable to the software industry.

There are a few potential explanations for why aggregate VC deal value surged in 2018, even as total deal volume declined:

  1. Continued strength of the public equity markets has created a favorable environment for initial public offering (IPO) exits. The S&P 500 increased to an all-time high of around 2,900 on September 1, 2018 before correcting to a low of around 2,500 by December 1, 2018. It should be noted that the trough of 2,500 is still higher than any point prior to around September 2017. There appears to be some correlation with stock market performance and IPOs, as out of the over 150 U.S. IPOs in 2018, there ranged 10 to 26 IPOs per month between January and October before dropping to 3 in November and 2 in December of 2018.[2]
  2. Despite rising interest rates, the overall financing environment remains favorable, which provides capital for corporate and private equity buyers. Venture capital and private equity dry powder is at record levels, exceeding $1.0 trillion at the end of 2017, and exceeding $1.1 trillion as of September 2018.[3]
  3. There has been an emergence of mega-funds including Softbank’s $100 billion Vision Fund established in 2016 and Sequoia Capital’s $8 billion global fund raised in 2018. Several other players have emerged in Asia, including funds backed by the likes of Tencent Holdings and Alibaba Group. These mega-funds provide ample capital for later stage investments, which in turn buoys the entire VC space.[4]
  4. Average deal value was up significantly, rising to more than $10 million in 2018. The overall trend in VC investment activity appears to be later stage investments making up a greater proportion of overall deal value. In terms of capital invested, deals of $50 million or more made up $68.3 billion in 2018 (excluding the JUUL Labs transaction). This is around 58% of total capital invested which is significantly higher than any other year over the last decade. In 2017, for example, deals of $50 million or more made up 44% total VC investments.

The past, however, is no guarantee of the future. There are a number of factors that may place downward pressure on deal volume and potentially valuations going into 2019.

  1. High equity market volatility in Q4 2018 may dampen the appetite for IPOs as pricing becomes less favorable. While January 2019 saw an equity market recovery, higher interest rates, trade tensions, and slowing global economic growth may continue to put downward pressure on public equities.
  2. Government shutdowns and the threat of future shutdowns slows the regulatory approvals process for IPOs.
  3. The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) expanded the purview of the Committee on Foreign Investments in the U.S. (CFIUS) to include non-controlling investments in companies’ critical technologies or other technologies with national security implications.[5] This will potentially reduce the amount of inbound venture capital investment from countries such as China.

 


[1] “Venture Monitor 4Q 2018”, Pitchbook Data, Inc. and National Venture Capital Association

[2] Data provided by Pitchbook Data, Inc.

[3] Preqin Quarterly Update: Private Equity and Venture Capital Q3 2018

[4] Griffith, Erin, “$100 Million Was Once Big Money for Start-Up. Now, It’s Common”, The New York Times, August 14, 2018

[5] Croley, Steven, Benjamin Potter, David Concannon, Les Carnegie and Edward Shapiro, “How FIRRMA Changes the Game for Tech Cos. And Investors,” Law 360, October 10, 2018.