Measure Twice, Cut Once

Investors increased their scrutiny of deals in the third quarter of 2016, marking a now four quarter trend that has produced fewer deals and increased diligence cycles. Much of the investor uncertainty was being driven by the election in the US and the aftermath of Brexit. With the election now behind us, deal count has the potential to increase along with aggregate dollars invested. The trend towards more realistic valuations and increased diligence is a positive one, and we believe represents the new normal.

Tale of the Tape

Global VC investment in Q3, 2016 capped out at $24.1B across 1983 deals, marking a nearly 15% pullback in funding from the previous quarter, and the lowest quarterly funding numbers in two years. In the US, VC funding fell to $14B, down nearly 20% from the quarter prior. Median late stage deals in the US were down nearly 35% from a year ago. Europe saw total funding of $2.3B across 468 deals. In Asia, funding came in at $7.2B across 323 deals. Globally, VC investment is at an eight quarter low, but many believe 2017 will be a turnaround year, given the finality of Brexit and the US election, coupled with renewed IPO interest and an influx of Asian capital eager to be put to work.

Unicorn Fertility Rate on the Decline

Unicorns, those startups with $1B+ valuations, continue to see fewer and fewer births. The Unicorn boom that began in late 2013 with the rally cry from Aileen Lee of Cowboy Ventures, now has slowed to a near standstill for the last three quarters. From a high of 25 new unicorns in Q3 2015, this year has yet to witness a single quarter with double-digit entrants being added to the herd. This quarter saw eight newly-born billion dollar companies including: Compass, Unity Technologies, and OfferUp. Following the trend of increased scrutiny, investors seem more keen to invest dollars earlier in the company lifecycle, than rushing into later stage deals based on FOMO (fear of missing out). As startups realize that valuations create pressure to meet unrealistic demands, many are becoming more realistic in their valuation expectations come funding. We like this trend, there’s been a thinning out the unicorn herd, and those that reach unicorn status now, have a higher likelihood of maintaining high valuations upon exit.

The Headline Makers

As the list of unicorns thin and becomes a more accurate representation of viable businesses, the power law of funding becomes more evident. This past quarter the largest deals included: Uber and Airbnb in the US, Deliveroo in the UK, and Go-JEK, Grab and 51Xinyongka in Asia, represented some of the largest deals in Q3. All but Deliveroo, Go-JEK and 51Xinyongka were longtime unicorns, highlighting the appetite by investors to fund proven late stage businesses, especially in the US.

Building off the M&A momentum of Dollar Shave Club and from late Q2, 2016, we saw two strateic M&A plays, with Salesforce making another run at the productivity space with the $582M acquisition of Quip, while Google picked up Apigee for $625M as it increases its focus on corporate clients and enterprise services offerings.

The largest European exit was out of the Netherlands, filing their IPO at $328M. In Asia, Mtime was picked up by Wanda Group for $280M. Overall the US was where the majority of Q3 exits took place, accounting for nearly 60% of the number of exits, but a whopping 80+% of aggregate exit value. M&A was still the dominant exit route, outnumbering IPO’s by nearly 10:1.

Public Envy

Twilio was the belle of the ball in Q2, 2016. With all eyes watching, the unassuming developer communication platform went public with great fanfare, and even greater initial success. True to their form, Twilio was livecasting a hackathon on the floor of the NYSE the day of their IPO. But with Twilio, the global appetite for public technology companies seems to have increased, with Europe seeing two large IPO’s ( and Nets A/S), while the US saw three of its own (Nutanix, Apptio and Trade Desk). Confidence in the public markets has permeated the founder community. But perhaps the biggest news comes as the darling of Venice Beach California, Snap, filed for their IPO as of this writing. Should that IPO go as planned it could be one of the highest-profile stock debuts in years.

We believe the public markets will continue to open up for more startups in 2017, after what’s been a rather anemic past few years. As later stage capital slows, we think many companies will need to seriously look to an initial public offering, whereas before they had the luxury of staying private longer. Overall a robust public market is a positive for the industry, it allows investors and employees to take capital off the table and reallocate it towards early stage companies, and it provides much needed public market equivalents from a valuation standpoint. Literal liquidity and knowledge liquidity make for a strong startup environment.

The Rise of the Corporates

Overall corporate VC investment rose for another quarter, as nearly all companies now view themselves as technology companies. Even traditional companies realize the strategic value that investing in startups can provide. The return for corporates can be significant, if managed strategically, from more agile innovation and creative solutions, to stronger data analytics and new sales channels. Over the past quarters, corporations have consistently ramped up their private investing activity, with more corporates either establishing CVC arms or investing directly in VC-backed companies off their balance sheets. The third quarter marked a five-quarter high for corporate investing with CVCs participating in 28% of all deals.

We believe the trends towards CVC participation will continue to grow. Bloomberg estimates that nearly $2.1T in profits are being held overseas to avoid corporate taxation. In fact Microsoft, Apple, (Alphabet) Google, and five other tech firms now account for more than a fifth of the $2.10 trillion according to a Bloomberg News review of the securities filings of 304 corporations. And the trend is increasing, the total amount held outside the U.S. by the companies was up 8 percent from the previous year. With that much cash being held overseas we believe there is a strong argument for a repatriation tax holiday, similar to what we saw in 2004. If that becomes reality, we could see a new influx of strategic CVC, as US firms put their money to work investing or acquiring US-based technology companies. However there are still questions to be answered from the likes of Janet Yellen and the Federal Reserve around their cryptic hints at interest rate hikes, which, would do more to drive much of the larger M&A deals than a repatriation holiday.

Finding Security in Cyber Security

2015 was a peak year for VC investment in cybersecurity, with almost $3.7 billion invested during the year globally according to CB Insights. And while there’s been a moderate drop in VC activity this year, cybersecurity startups are still raising significant funds. In the first half of 2016, cybersecurity startups saw more than $1.6 billion in funding.

As major industries integrate more programmatic, autonomous and networked technologies the threats from cyber-terrorists increase too. While larger companies have paid attention to the lessons learned by Target, Sony, and more recently Anthem, implementing systems to protect not only their data, but their stock prices, attackers have adapted. Moving downstream, attackers are shifting their focus to mid-sized organizations with less mature cybersecurity solutions.

We believe the best approach to cybersecurity is an integrated one, evaluating how technologies coexist with other existing products in the stack, as well as policies and processes, all while also looking at how offerings can assist in the governance of risk. Taking a more strategic view of potential cybersecurity deals enables investment in both the near term, while understanding longer-term early stage bets.

From a sourcing standpoint, Israel and Silicon Valley remain the two key cybersecurity hubs. Israel in particular has a predilection for financial services, specifically anti money laundering and the protection of money movement. Undoubtedly the IDF (Israeli Defense Force), helps to drive this prominent ecosystem. Silicon Valley still comes in a close second behind Israel, with many companies looking to build bridges between the two cybersecurity and technology ecosystems. Cybersecurity has long been core thesis of our firm, which is why we’ve gone to such lengths to foster relationships and our network in both Israel and Silicon Valley. Of our investments currently, OPAQ Networks, Mocana, Blue Cedar Networks, and HyTrust are all investments we’ve made under the thesis that cybersecurity is an essential component of all enterprises.

CVC participation is key component of the private cybersecurity venture landscape. We’re seeing corporate investors across industries making investments in cybersecurity startups that can help them better defend themselves, or that have technologies they can apply to accelerate their cyber security defenses. We believe that as more industries become the targets of cyber security attacks, the volume of CVC participation will likely grow.

Virtualize More

One particular investment who sits at the epicenter of both the increase in need for cyber security as well as the newly evidenced public market appetite is HyTrust. As a firm, HyTrust specializes in security, compliance and control software for the virtualization of information technology infrastructure. HyTrust offers IT managers and administrators of virtual infrastructure a centralized, single point of control for hypervisor configuration, compliance, and access management. As companies move to the cloud and implement public, private, and hybrid environments, HyTrust capitalizes on this trend in increased virtualization. Among its strategic investors are the likes of: Cisco, Fortinet, In-Q-Tel, Intel, and VMWare. This handful of strategics and corporates echos the trends we’re seeing across cyber security of increased CVC participation.

HyTrust also stands to benefit from the recent IPO of Nutanix, and their subsequent success. Nutanix makes IT infrastructure invisible with an enterprise cloud platform that delivers the agility and economics of the public cloud, without sacrificing the security and control of on-premise infrastructure. The Nutanix IPO was not only a positive sign for the IPO market, but great for the IT infrastructure industry. Nutanix now serves as a favorable public market comparable (PMC) for HyTrust. This PMC could not come at a better time as we’re engaging a 3rd party validation for HyTrust likely in Q1, 2017, as they will likely not raise another round of financing before an exit.

Overall we’re seeing positive trends as we head into 2017 and believe that many of our portfolio companies are in unique positions to capitalize on them.