“VC Bubble” a Reflection of Public Markets

There has been quite a bit of “VC Bubble” talk of late. The subject is a nuanced one, and anyone who says “Yes” or “No” is overly simplifying the situation. In this post, I’d like to focus in on one aspect of the question: the public markets. As much as we in the startup world like to think of ourselves as leading an important part of the financial world, the reality is that Venture pricing is a lagging indicator of public market sentiment.

Since the low point of the Financial Crisis in early 2009, the stock market indices have been on a steady upward climb, and valuations in the Venture Capital markets have followed suit. The graph below shows the NASDAQ (QQQ) End of Quarter prices for the last 20 quarters, indexed to the initial value.

NASDAQ (Adjusted QQQ) End of Quarter prices, indexed to Q1, 2010.

The good people at Wilson Sonsini — who are in an excellent position to see a broad swath of all Venture financings — have been kind enough to publish detailed financing data on a quarterly basis for the last 20 quarters. The WSGR data gives us median post-money valuations for all the Series A, Series B, and Series C+ financings they were involved with that closed in the quarter.

Median Series A Post-Money valuation. As reported by WSGR Entrepreneurs Report.
Median Series B Post-Money valuation. As reported by WSGR Entrepreneurs Report.
Median Series C+Post-Money valuation. As reported by WSGR Entrepreneurs Report.

While the data points bounce around a bit, all three charts are striking in their similarity to the NASDAQ price graph for the same time period. There are, of course, other interesting things to consider:

  1. Dichotomization between the hot and the not hot companies. There has been some discussion that Venture financings have become a tale of two groups: a small number of super hot companies raising large amounts of capital at high valuations, and a larger number of companies working very hard to raise small amounts of capital at low valuations. But, the fact that median valuations have been climbing in line with the public markets suggests that things are not far out of line for a majority of the private companies.
  2. A company raising a Series A today is generally further along than a company raising a Series A five years ago. With more Angel money available and increased capital efficiency, a Series A company is simply more proven and more valuable today than it was five years ago. By the same logic, a company raising a Series B or C+ today is more proven and valuable than a company raising a round with the same sequence label five years ago. To the extent that it is true, it is a “counter-bubble” argument.
  3. Public company earnings have climbed over the last five years. Price to Earnings multiples haven’t climbed as much as the share prices themselves. This is certainly true, and is also an argument that it is rational to have higher earnings expectations for pre-revenue, or early revenue, Venture backed companies. Therefore, a price-based metric is probably a better yardstick than a multiple-based metric.
  4. Late stage Unicorn deals and their reported lofty valuations. A healthy level of caution should be exercised in interpreting the reported valuations of some of these financings. It is quite easy to craft a deal that has an eye-popping headline valuation, but which results in a much higher level of ownership for the investor in some/many/most outcome scenarios. Now, the insiders I’ve spoken with swear that the big valuations at their Unicorns weren’t overly structured deals, but that is a tiny subset of all such companies.

The bottom line is: yes, valuations for Venture financings have risen sharply over the last five years. But, I would argue that this is primarily a simple reflection of market sentiment that shows itself most directly in public market prices. The fact that companies are further along in their development for a given Series of financing than they were five years ago argues that valuations are relatively less changed in the median Venture financing than in the public markets.

Thanks to Roberto Bonanzinga, and Eric Little and Herb Fockler at Wilson Sonsini, for comments on the draft version of this post.

The thoughts and opinions in this post are mine and mine alone and not affiliated in any way with Recursive Capital LP, Recursive Capital LLC, or any other company I am involved with. Nothing written in this post should be considered investment, tax, legal, financial or any other kind of advice.