With venture capital fundraising and startup financing rounds at an all-time high, some practitioners are beginning to caution about a possible bubble formation in the asset class.
Although current market conditions are only occasionally compared to those of the dot-com heyday, frothy valuations and a possibility of a nearing downturn are beginning to be discussed more widely.
A recent thought piece by Hamilton Lane titled “The Myth of Peak Venture,” argues that despite seeming excesses in the industry, venture remains on strong footing and the repeat of an internet bubble is unlikely.
A report by the large financial service firm states that venture has consistently outperformed the broader private markets and its public market benchmark over the last 10 years.
The thought piece, which tracked a few thousand funds, is authored by Miguel Luiña, a principal who runs Hamilton Lane’s VC and growth equity primary fund investments.
His report outlines reasons why venture has been performing well and why current conditions do not point to an overheated market. Among the report’s findings:
- Globalization of venture. In 2000, $53.5 billion or 81 percent of all venture capital targeted North America, according to Hamilton Lane’s report. Eighteen years later, VC commitments for North America increased to $68.5 billion, but its percentage of the global market decreased to 39 percent, the report states. The geographic distribution of unicorns confirms this trend. Less than half of all unicorns are now U.S.-based. As the venture community seeks out opportunities worldwide, more funding is needed to make those investments, Luiña said.
- Late-stage funding. As companies stay private longer, their growth is being fueled by venture funding. As long as the trend for longer period to IPO continues, more venture and growth equity funding may be necessary.
- Non-institutional seed capital. In today’s venture funding environment, first institutional checks are often written to startups that have already raised large amounts of cash from friends and family and angel investors. Availability of this “pre-funding” means that VCs are often investing in more mature and less risky companies, argues Hamilton Lane.
- Lower startup cost. In the late 1990s, new startups had to spend sizable chunks of their early funding to buy servers and other tech equipment. Today, nascent companies can use third-party providers for most IT infrastructure needs, freeing up capital to focus on core products and market adoption. The ability to expand faster and lower upfront costs generally warrant higher valuations, the report says.
- Path to break-even. Many VC-backed companies burn cash. But unlike the dot-com startups, the current batch of companies can get to break-even if they choose to reduce their spending on sales and marketing and expansion efforts. This lowers the downside risk for venture capitalists.
- Larger addressable market. Exits of venture-backed companies have increased as the overall technology market has expanded. Current startups generally have larger addressable market, which means they can eventually grow into more sizable and valuable companies.
Although venture remains a risky asset class, the risks are not what they were during the dot-com bubble, the report says.
The venture industry is creating significant value for its investors, Luiña argues.
Sitting out on the sidelines because the asset class may appear to be overheating is the “riskiest move of all,” suggests the thought piece.