Venture capital firms are raising so much money that it is fueling an overfunding of companies.
Some 259 U.S. venture capital funds amassed $46.3 billion in 2019, the second highest by amount of capital raised and the number of funds since 2006, according to the PitchBook-NVCA Venture Monitor. The biggest fundraising year since 2006 was 2018, when 299 venture capital funds raised $58 billion.
With all of that capital, some venture capital firms have been hunting for potential unicorns, companies worth $1 billion or more. Investing in the next $1 billion-plus unicorn has become a badge of honor and marketing tool, and the massive amounts of capital pouring into the asset class is fueling a lack of discipline and a recent drop in the number of exits as companies struggle to match their optimistic valuations, industry insiders say.
"There's a desire to attain a $1 billion valuation ... whatever the round number is," and these venture capital firm executives are stretching to get there, said Ed Zimmerman, New York-based partner and head of the technology group at law firm Lowenstein Sandler LLP.
This "lack of discipline," mainly in late-stage investment, he said, has led to an increase in so-called vanity valuations, portfolio company valuations that are larger than may be justified by the company's performance, he said.
According to the PitchBook-NVCA report released Jan. 14, there were 237 megadeals in 2019, transactions worth $100 million or more, that were valued at a combined $59.5 billion, fewer than in 2018 but the second highest on record. More of these megadeals were for new, early stage companies, with 22% of the deals being early stage mega transactions in 2019, the PitchBook-NVCA data shows. The lion's share of the megadeals, 76%, were for older, late-stage companies. Five year's earlier, 10.7% of the megadeals were early stage companies with the percentage on a jagged upward trajectory since then.
These valuations are not supported by the by recent transactions of comparable companies or by any other metric, Mr. Zimmerman said.
Due to the abundance of capital raised by venture capital and growth equity funds, money is being spent by some managers based on the need to deploy capital, Mr. Zimmerman said.
Compounding the situation is the historic opacity of the venture capital and startup market, he said.
"There's no disclosure of performance until a company is public," he said. "People in the loop will get varying degrees of information and information can be very powerful."
Some industry insiders say these vanity valuations are making it more difficult for venture capital firms to exit because not all of the companies are able to sell or go public at those high valuations, he said.