It is no secret the IPO market for venture-backed companies has been galloping along this year.
One observer paying close attention is Bob Blee, head of corporate finance at Silicon Valley Bank. Not only has an attractive supply of technology companies and an abundance of capital contributed, but so has low market volatility and improving valuations, Blee said.
Blee also is upbeat on mid-market tech M&A.
VCJ recently had the opportunity to speak with Blee. An edited transcript of the conversation follows.
Q: The IPO market has been strong this year. What is behind the improvement?
A: What we have now is a period of low volatility and steadily increasing valuations, coupled with a significant inventory of tech assets and a massive supply of capital seeking tech assets to invest in or acquire. That’s the environment we’re in.
It’s hard for me to recall a time when all these options have been so attractive simultaneously: the options of investing, going public or being acquired.
Q: What are you seeing with valuations and volatility?
A: When we look at volatility, we’re looking at a VIX [or volatility index] steadily under 20. Notwithstanding the blip that happened in February this year, where it shot up temporarily, we’ve been at a steady under 20 clip for some time now. That’s despite all the discussion around trade wars and other issues.
On valuations, what we’ve cited is the cloud index, so it’s recurring-revenue SaaS businesses. The valuations have steadily climbed over the last couple of years from a low of around 4x revenue up to approaching 9x revenue.
Q: Do you have expectations for the second half?
A: Our belief is the trend will continue as we’ve seen in the first half. The number of high-quality scale companies that are either filing privately or are looking to file continues to be strong. Outside of macro factors dampening the exuberance, we think the second half is going to be strong on the IPO front.
Q: What do you think about the M&A environment for mid-market companies? Has there been an increase in activity?
A: We think there has. There is a lot of focus on large acquisitions. The vast majority of the over-billion-size acquisitions are being made by strategics.
We thought it would be interesting to look at the $250 million to $1 billion range. There you see that a significant amount of acquisitions have been made by tech PE. We think this is significant because these investors are comfortable paying these elevated prices and because perhaps these tech giants are now at a scale where the deals of this size in general may no longer be relevant or transformative to their companies, which [creates] an opening for PE.
Q: What does this say about the period ahead?
A: If you start from the capital standpoint, we calculate just in the U.S. there is PE dry powder that is intended to be invested in technology of $107 billion. The clock is ticking on those funds and the expectations are they will be invested.
Outside the macro factors that could turn the market, we think this a trend that is just going to pick up speed.
Q: With respect to China, you see a younger herd of unicorns growing up. What is taking place?
A: The Chinese unicorns are on average three years younger than the U.S. unicorns. This shows a lot of excitement about China as an emerging market for venture with lots of opportunity.
The ecosystem there is still developing, but there is just huge opportunity to allow startups to quickly scale. There is a lot of dry powder, over $100 billion just in RMB funds. There is a lot of capital and there’s a lot of market opportunity. So the speed with which these companies grow is almost unheard of in the U.S.
Q: So the ratio of younger unicorns to older unicorns is substantially different?
A: The distribution of unicorns in terms of their age is dramatically different in the U.S. vs. China.
Look at young unicorns, four years or newer in terms of when they were established, and older unicorns of 10 years or older. In the U.S. the ratio is 1-to-4, which means the vast majority are older than four years. In China, it is 1-to-1.
Q: Are we seeing a U.S. funding bubble in artificial intelligence?
A: I don’t think so. The way we’re thinking about it now is really by the application of AI.
If you break it down by vertical, you certainly see a significant increase every year, including this year, in the percentage of deals that are done that have an AI element. So roughly 1-in-10 startups have an AI element.
If you look at the categories we highlight: AI plus cybersecurity; AI plus digital health; AI plus fintech, it’s all growing. Between 8 percent and 17 percent of the deals in those categories have a strong AI element.
We believe it is still early days in the application of AI, and so we don’t see a bubble.