Sand Hill Road: Bay Area venture market remains king

The state of venture capital appears to be rocky at the moment.

A report from PitchBook Data and the National Venture Capital Association highlights potential weakness ahead in the venture industry. The Pitchbook/NVCA Venture Monitor First Look report showed fewer active investors and high deal counts but repeat investing.

What does that mean for the Bay Area?

Sand Hill Road Host Scott McGrew spoke with Kyle Stanford, the Lead venture capital Analyst at PitchBook, to understand the report and its impacts locally.

A transcript of this episode is below.

0:14 I think the one thing is that that's never going to change, right?

0:16 If you look at San Francisco and, and kind of Bay Area in general, there's so, so much capital here, and there's also pre-seed investors all the way through those crossovers that you need to, you know, get your pre-IPO around.

0:29 I'm Scott McGrew. Welcome to Sand Hill Road.

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1:13 This week, a look at the health of the venture world with PitchBook's Kyle Stanford.

1:18 So I think what's going on in venture right now is really interesting.

1:21 PitchBook's latest report, technically called the PitchBook NVCA venture monitor first look, shows weakness ahead in the venture industry.

1:33 When I went through the report, two things that really stood out to me were fewer active investors and that the deal counts were high, but a lot of that is repeat investing. Tell me about that.

1:46 Everyone knows what happened in 2021 and the really active market was going on a really fast market. I think there was about 25,000 or so unique investors that made a deal in 2021 that was a huge increase over a couple of years prior. Now we're looking at 55% fewer investors have made a deal so far this year.

2:04 And so when you talk, when you hear about a slow market and you kind of wonder what that means and there's fewer capital, there's fewer investors. So now companies that are looking for capital, have fewer options to go out and try to raise that capital from. So, I think that's a really big part of the slowdown in what's going on in venture right now.

2:22 What's causing that?

2:23 Yeah. Right. So I think everyone knows also that there's no IPOs and no M&As happening.

2:27 So there's fewer distributions, fewer returns. Venture is just not performing like it was, you know, through the bull market from, you know, after the global financial crisis. So what we've seen, we've seen a lot of crossover investors pull back to their traditional strategies. Angel investors that had gone active and put money into the market have now slowed their pace or pulled back from the market. And it's just not as much activity because that return is just not there, right now.

2:49 The returns of the quarterly distribution money back to the investor you wrote it is close to where it was during the global financial crisis of [2009]. That's, that's quite the comparison.

3:02 It is. And I think also if you look at any of the dip that we saw in that statistic in 2009, it was relatively short and shallow. Now, we've been close to that figure for about eight quarters, which is really, really interesting. I think that, you know, from that, you know, it's, it's almost as low as there, but the market is so much bigger as well.

3:19 And so when you look at the AUM of the market, how much money or how large the, the market has grown now with fewer money, you know, coming out, you can really see why fewer investors are investing and fewer people are interested in, in actually actively putting money into to VC right now.

3:32 And in your report, unicorns, you write, account for roughly 2.5 trillion in value and are aging. Nearly 40% of the companies in there have been in the portfolio for at least nine years.

3:46 Yeah, and why that's important, right? If you think about venture as a traditionally a 10 year fund term cycle, right So raise a fund, hopefully distributing it back in 10 years. Now, if you've seen these unicorns that are holding somewhere around two-thirds of market value are starting to really age and been held in portfolios for nine plus years, you start to see that strain on the market returns and why, you know, few exits and few IPOs are really starting to clog up venture.

4:10 I think there's 750 or so unicorns in the US. That's going to take a while to, to play through, even if the IPO market does, you know, miraculously open up

4:19 And if investors aren't getting their money back, then they're not reinvesting. It's all been locked up in these unicorns.

4:24 That's right. I mean, if you look at fundraising for, for new commitments to VC funds, we're gonna, you know, be the second year in a row where there's about half the amount raised in 2021 and 2022 -- which were the, the record high years. So I think we're on track for somewhere around 80 billion in new commitments to VC. That is gonna really put a strain on deal-making moving forward.

4:43 And we know there's a high number of companies that are still going to be looking for money in the private markets, and with fewer new funds ready to put money to work over the next few years, it's gonna be really a strain on those capital allocation resources for, for VC-backed companies..

4:55 You do sort of rate the chances of certain unicorns going public. One of the highest probabilities you have is carbon. That's a fascinating company. If anyone's ever seen Terminator Two, it's to watch them build things. They don't, they print out of, out of, you know, a substance, but it's more like the Terminator coming together. It's absolutely fascinating to watch.

5:19 You rated that as one of the most likely to go public.

5:21 Yeah. Right. So our VCX Predictor really takes all the data that we have in our database and, and kind of tries to predict, you know, which companies are likely to IPO versus M&A and what the probability of those successful exists is going to be.

5:33 And you look at someone like Carbon, and some of the other companies that are really high on that list, you know, IPOs really are a financing event for companies, right? The returns are a great aspect, but these companies do need to continue raising it to continue growing. And, so when you look at these, how developed some of these companies are, especially the capital intensive ones, you know, IPO is definitely going to be one of the steps for, you know, the next steps for growth in these companies stories.

5:52 Well, so there are some that, you know, continue to raise from venture capitals. Anderol Industries, it's a company, it's a defense tech company that uses AI in weapons systems, raised a $1.5 billion Series F. I mean, if I would have said that 10 years ago, you would have laughed, right? 10 years from now, maybe we'll talk about a new company raising 20 billion in its Series W.

6:16 You know, I was on a couple of panels yesterday and one of the themes that came out of it was that, you know, good companies are gonna be able to raise in any market, right? So if you look at someone like Anderol, OpenAI, where all of this, you know, excitement is, those companies are going to be able to raise if they continue growing at the incredible speeds that, that they have been.

6:32 Obviously a Series F that's way long, but there's also this aspect where it's the regulations to go IPO and the costs that are associated that are really disincentivizing for companies to actually go through that exit. So for those companies that are able to raise in the private market, that is a huge, you know, you know, cost saver and the capital is there. Those crossover investors are willing to put money into Anderol and they're willing to put it into OpenAI. So the companies that can raise from the private market are still, you know, making sure they tap that resource

7:00 And when we look at valuations and they're growing, you mentioned AI. A I companies are really skewing the average and that's where the money is going.

7:09 Oh yeah. I mean, we have this one model that we use called the deal- making indicator and kind of judges the investor friendliness for start friendliness of the venture market. So if you take the venture market as whole, it's obviously very, very investor friendly. But when you look at A I specifically, that comes very much closer to a balance even in this slow market. So it's higher valuations. It's larger deal sizes. It's a faster pace of investment, and, you know, cleaner term sheets that AI companies are getting right now. That's really where, you know, everyone has kind of turned their gaze and turned their focus for investment at the moment.

7:07 I am amazed at how much money some of these companies are able to repeatedly raise. Ro is a men's health care They've raised $1 billion. Alphasense $1.4 billion. Impossible Foods, $1.8 billion. Stripe $8.7 billion.

7:27 I mean, I will caveat Stripes, right? They use six or so billion in that for share buybacks from employees and existing investors, right? But like again, you know, these companies that are showing growth and they are showing the stability and are going to be the companies of the future, are getting the loan large dollars from crossovers. We've seen corporates be very active, especially someone like a Microsoft or Amazon that has the dollars to spend. So, you know, capital is out there for these companies.

7:50 And yeah, it seems crazy, especially thinking a few years ago about companies raising a billion dollars, you know that single round or you know, billions over their lifetime as a private company. But you know, investors see where are looking for the companies that are going to become the next hopefully trillion dollar company. So when it makes sense to put that much money to work, especially if it's a capital-intensive industry that, that requires it. I think the money's out there for the good companies.

8:13 Cerebras said it filed the papers, it needs to go public. It'll be the first major tech company since Rubrik. And I will mention to our, our listeners that Rubrik's CEO Bipul Sinha has been on this episode, you can look for that in the archives. What's the environment for Cerebras out there?

8:29 Right. I think it would be really interesting. I mean, we know the fed cut rates by a 50 basis point, which is something that everyone's been looking for. It's not gonna, you know, just become you know, a VC-backed company friendly market instantly. But, you know, seeing a big tech company try to test the waters and I'm sure someone like Cerebras, and kind of the story they're able to tell to investors would be really important.

8:49 But I think, you know, a good market for them or a good performance post IPO I think it will be really positive impact on, on VC. I don't think that it's necessarily the, it's now nowhere near the friendly market that we saw a couple of years ago.But Cerebras obviously is looking at their, you know, capital stack and, and knowing where their growth is going and, and think they have a good shot at doing a high-quality IPO

9:11 Talking about the venture capital industry in general. I had a string of guests who were going out and raising their own funds. They would leave the Andresson and the Khoslas to create their own. There was a, there was a spate of those for quite some time. I'm guessing there are gonna be fewer of those in the future.

9:27 There will probably not nearly be as many as there were then.

9:30 I think we saw a lot of people that, you know, maybe weren't ready, able to raise a fund then, but, you know, going out on their own is, is always going to be what many of these really, really strong investors want to do. They know their strategy. Maybe it's differing from, especially the larger firms that have continued to grow and grow and grow. So striking out on their own is, is not gonna go away, but it'll definitely be a different, different, you know, opportunity to raise capital.

9:53 I guess it probably won't be as fruitful as it was in 2021.

9:56 And then lastly, let's talk regions, you, you break things down by regions. And I've looked at the report but even a solid guess would be California still leads the way.

10:07 I think the one thing is that that's never going to change, right? If you look at San Francisco and, and kind of the Bay area in general, there's so, so much capital here and there's also pre-seed investors all the way through those crossovers that you need to, you know, get your pre-IPO round.

10:20 And so California in general, but especially the Bay Area, is always going to be the premier spot for VC.

10:27 You know, we've seen New York become like a very, very strong second place with the same thing that goes there.They've got the pre-seed all the way through. So, you know, California is where the most capital is. And so it's going to keep it being the, you know, again, the premier spot for VC.

10:40 But you know, I think, you know, we've seen great companies come out of Utah, we've seen great companies come out of Chicago. There's a lot of emerging markets that are just kind of, you know, waiting to buy their time for the next unicorn.

10:54 Kyle Stanford from PitchBook.

10:56 Next week on Sand Hill Road.

10:58 Do you hang out with the guys from Cards Against Humanity?

11:00 I do all the time.

11:01Yeah, seriously?

11:02 Really.

11:03 Elan Lee, co-founder of the game and company Exploding Kittens, taking $40 million in venture money.

11:13 Sand Hill Road is produced and edited by Andrew Mendez. Sara Bueno manages NBC Bay Area's digital platforms. Stephanie Adrouny is the news director. If you'd like to get in touch, email us at SandHillRoad@nbcuni.com.

11:30 Thanks for listening. We'll see you next time.