2016 Exits — Year in Review
All quiet on the exits front — a theme of 2016 — though the innovation and excitement that fuels the venture capital ecosystem never stops. Silicon Valley Bank is releasing its first quarter State of the Markets report in the coming weeks. As a preview, I’m covering exits specifically as 2016 offers insights to what we can expect in 2017. Visit SVB.com to sign up and receive the new State of the Markets report when it comes out.
Before we dive into 2016, let’s take a look to 2015. Crossover investors (Tiger Global, Wellington Management, Goldman Sachs, Fidelity, etc.) had flooded the private markets, participating in venture capital rounds totaling $29 billion for the year. The excess supply of capital caused late-stage valuations to skyrocket, resulting in a massive backlog of billion-dollar companies in the private markets. It seemed as though investors were buying into these high-profile names under a FOMO (fear of missing out) mentality, and the wildly popular term “unicorn” was born.
With bad memories of the dot-com bubble still lingering, the funding craze in 2015 certainly did not go unnoticed. Some investors, such as Silicon Valley–based VC firm Andreessen Horowitz, defended the valuations explaining that companies were staying private longer thus shifting value creation historically happening in public markets to private markets. They also pointed out that, unlike the dot-com bubble, the companies raising capital possessed strong fundamentals, real customers and sound business models. At that time, the elephant in the room was the valuation disparity between the public and private markets; it was clear that most of these private companies would have to grow into their valuation over time.
State of Recalibration
Although signs of this valuation problem affecting the IPO market first emerged when the “IPO as a down round” conversation began in late 2015, it became clearly evident in the first quarter of 2016 when the public markets took a turn for the worse. The situation was exacerbated by the poor performance of recent IPOs, with several of the once-high-flying tech companies losing a significant portion of their market cap. Private companies lost all confidence in their ability to top their last private valuation with a public offering, and thus the IPO market froze completely. We saw zero technology IPOs in the first quarter of 2016, and there were no signs of the conditions improving.
The comatose first quarter brought a healthy recalibration to the private markets. Companies began shifting their focus away from top-line growth to burn rates, unit economics and a path to profitability. For the early-stage companies, managing capital requirements during these times became essential to ensuring that they were not forced to raise in a challenged financing environment. For late-stage companies, it became clear that showing strong fundamentals to public investors would be a prerequisite for IPO. In both cases, the power quickly shifted from entrepreneurs to investors, and VC capital was nowhere near as easy to come by.
It is important to note that the other side of the venture capital industry, the healthcare sector, did not face quite the same challenges as we saw in the technology space. With 28 VC-backed biopharma IPOs for 2016, along with some large M&A deals with AbbVie announcing the acquisition of Stemcentrx ($5.8 billion upfront and $4 billion in milestones) as well as AstraZeneca completing the majority stake (55%) in Acerta Pharma ($2.5 billion upfront and $1.5 billion in milestones), healthcare companies continued to generate outsized returns for investors. We also saw a shift towards early-stage (Pre-Clinical, Phase I) M&A transactions this year, translating into faster liquidity and more attractive IRR metrics for investors in the healthcare sector. For a deep dive into healthcare sector, read SVB’s Healthcare Investments and Exits 2017 report.
As the IPO markets slowed in 2016, M&A became an attractive path to liquidity. With many companies struggling in the public markets, public M&A was particularly active with formerly VC-backed names such as Marketo ($1.8 billion acquisition by Vista Equity Partners) and Demandware ($2.8 billion acquisition by Salesforce) proving attractive targets to both strategic and financial buyers. Deal size was no inhibitor as acquirers also sought value in larger elephants–e.g., LinkedIn ($26.2 billion acquisition by Microsoft) and NetSuite ($9.3 billion acquisition by Oracle).
The most exciting story with M&A in 2016 was the increased appetite that emerged from non-tech, legacy corporates. With a growing number of mature companies now starved for innovation, corporate investments in the technology sector have become increasingly popular through the creation of venture capital investment arms as well as strategic M&A. Jet.com ($3.3 billion acquisition by Walmart), Dollar Shave Club ($1 billion acquisition by Unilever) and Cruise Automation ($1 billion acquisition by General Motors) represent three of the largest private M&A transactions in 2016, all involving companies outside the technology sector.
It appears technology is on its way to becoming a broad layer across the economy, rather than a single sector within it. If this holds true, the increasing pool of potential acquirers bodes well for the entrepreneurs and investors who are looking for liquidity options.
Throughout the second quarter, IPO activity remained quiet despite the spectacular recovery made by the public markets. Acacia Communications broke the ice with a successful offering in May, but it wasn’t until the very end of Q2 when Twilio posted huge gains at and after its IPO that we started seeing some momentum and confidence flow back into the private markets. This brought out a few more notable IPOs in the second half of the year (The Trade Desk, Apptio, Nutanix, Coupa Software), but the macro challenges and uncertainties surrounding the Brexit decision and the U.S. presidential election kept things relatively quiet. The companies that chose to go public received a warm welcome from Wall Street, most of which experienced large first-day pops and post-IPO rallies.
The momentum that we witnessed for many of the 2016 offerings was likely driven by a variety of factors including the absence of recent IPOs, bankers pricing the new listings modestly, lockup periods and companies magnifying stock movement by selling only a tiny percentage of their total stock in the IPO. The result was a lot of momentum but also a lot of money left on the table — Twilio (92 percent first-day pop), Nutanix (131 percent first-day pop), Coupa Software (84 precent first-day pop), The Trade Desk (60 percent first-day pop), and Apptio (40 percent first-day pop) could have secured an additional $650 million in aggregate cash on the balance sheet. However, there are certainly reasons why these companies probably wanted to see a first-day pop, including the publicity from initial gains, securing that sense of loyalty from long-term investors who access early profits, and, of course employee morale. Depending on the situation, these factors often outweigh a maximum cash influx.
There may have also been a touch of irrational exuberance from public investors that helped drive some of these stocks to unsustainable levels. There’s no denying that 2016’s IPOs were the most fundamentally expensive stocks in the technology industry, yet investors still found these companies attractive. As a result, much of this momentum was ephemeral, and many of the 2016 IPOs are now at or below their first-day closing prices. In spite of this, 2016 tech IPOs in aggregate (equal-weighted) still finished the year 39.8 percent above where they debuted, more than five times the returns of the Nasdaq for the year.
2017: The Year of Liquidity?
After the extended drought of VC-backed tech IPOs in 2016, the forecasts indicate that activity may pick up in 2017. To start, there is a huge backlog of IPO candidates beginning to grow into their private valuations (125 unicorn companies were created in 2014 and 2015), and investors will certainly be looking for liquidity. Moreover, the strong public market performance of 2016 IPOs and the recent S-1 filing (confidential filing) of Snapchat further suggest that the market may be poised for a rebound. Alongside Snapchat, the S-1 filing of Appnexus (confidential filing) and Cisco’s $3.7 billion acquisition of AppDynamics have given us real visibility into 2017 unicorn liquidity. If these exits are successful, we could see a significant influx as confidence in the IPO market is restored. The biggest questions remain around valuations and whether or not these unicorns will feel confident putting themselves to the ultimate test of supply and demand. While some companies with cash flow constraints may be forced into an IPO as a down round, others will be able to create substantial value at and after IPO as they grow into the next big worldwide enterprises.
For the venture capital industry, 2015 was the year of funding. 2016 was the year of recalibration. 2017 could be the year of liquidity.
State of the Markets 2017
SVB is releasing the new State of the Markets report on the coming weeks. Visit SVB.com to download our last report and subscribe to receive the new report.
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