How much should public equity investors care about the global venture capital industry? In past cycles, the answer was “Not much”. Yes, VCs added some fuel to the 1990s dot com fire. But aside from that, equity investors have been safe in assuming that VC money tended to be parochial, focused on smaller startups, and longer on clever ideas than capital. An interesting niche in the capital markets, to be sure, but nothing more.
Now, venture capital has become a global checkbook for technological disruption on a scale that dwarfs any prior period in market history. A few data points from a recent report by Crunchbase, a comprehensive source of VC deal information:
- First half 2018 saw $175 billion of venture money invested, which exceeds the annual totals of any year between 2012 and 2016.
- Even assuming volumes slow in the second half, 2018 is set to easily top last year’s total of $212 billion.
To put some scale around that number, it is about the same as Intel’s market cap ($223 billion), well north of Citigroup ($174 billion) and almost double IBM’s market value ($130 billion). And that’s just in one year.
- In July alone, there were 55 venture rounds of $100 million or more, raising just over $15 billion. Companies based in the US (42% of those deals) and China (40%) dominate the list in terms of where that money went. The latter is a relative newcomer to the 9-figure deal club; just 5 years ago Chinese companies only represented 14% of super-sized rounds.
We believe there are 3 important points for public equity investors to consider from this remarkable surge in venture funding.
#1. While the increase in total capital available to venture stage investing may seem like one more sign of a market top (for Technology, at least), there are some macro reasons capital is shifting here:
- Persistently low global interest rates.
- Lackluster public equity market returns over even multi-decade timeframes.
- Fewer investment options in public equity markets, especially in early stage Tech companies.
- Pension funds seeking to improve returns in light of the prior points by pushing incremental capital further out on the risk spectrum.
No, none of these points necessarily make VC investing inherently more attractive. The actual returns of the investments drive portfolio results, of course. But they do explain why there is much more capital available than prior cycles.
#2. VCs look at the world very differently from stock market investors. They tend to see the profit margins of large companies (the S&P 500, for example) as their target. Those are famously at record levels, and as Jeff Bezos once said, “Your margin is my opportunity”. At the top of any business cycle – including this one – those opportunities look very large indeed.
Importantly, this isn’t just wishful thinking because there are three important tech-based trends in play right now:
- Global Internet: Half the world (and all the wealthiest parts) has access to the web and the other half is coming along.
- Global mobile computing. A third of the world’s population has a smartphone and lower prices will keep adoption climbing.
- Moore’s Law. Semiconductors continue to double in computing power/dollar every 2 years or so. That means in 10 years the typical smartphone will be 15x more powerful than it is today.
#3. Even if the current pace of venture capital investing slows (and it will), there are plenty of seeds in the ground already. Public companies (mostly in the Tech sector) will purchase many of these and fold them into their operations. Other will eventually go public. And, of course, many others will fail along the way. While all that happens, venture capital will continue to raise more capital and continue to invest.
Summing up: the remarkable growth of venture capital in the current cycle is not simply animal spirits at their worst, so we do not take it as a sign of a precarious public equity market. It will ebb and flow, as it always has. But the opportunities are clear, even if some valuations are “wrong” by traditional measures. VCs don’t need every investment to pay off; just a handful of winners make their game work. And those few are enough to disrupt scores of public companies.