When Evaluating Venture-Backed Initial Public Offerings, Patience Is a Virtue

The venture capital industry has created a robust pipeline of new public companies, but in our view discipline is the key to finding the best opportunities.

2019 has been a rough year for the venture capital industry. Multiple high profile IPOs have either fared poorly (e.g., Uber, Lyft, Slack, Peloton) or been postponed (e.g., WeWork), tarnishing the industry’s reputation and triggering a wave of negative press.

Lost amidst the headlines is the significant fact that over 80 venture backed firms have gone public already this year, and another 134 went public last year1. These totals indicate that the VC industry is thriving, which is good news for managers like us. Not only does the creation of new public firms expand our investible universe, but more importantly, VC-backed emerging firms generally exploit the types of secular growth trends that we believe are the true drivers of both revenue growth and returns.

Venture Capital Has Evolved

The venture capital industry has been growing steadily for the past decade and is now a powerful economic force. Venture backed firms impact society in a variety of profound ways, whether or not they’re public. Ridesharing giants Uber and Lyft began transforming how people get around long before their recent IPOs. Likewise, AirBnB has fundamentally changed how people travel, even though it’s still private. And Beyond Meat is having a similar impact on how consumers think about hamburgers and other meat products.

As the chart below demonstrates, over the past ten years domestic VC activity has been steadily increasing across all three major dimensions: fundraising, investing, and exits.

U.S. Venture Capital Activity

Source: 4Q 2018 PitchBook-NVCA Venture Monitor

The VC industry is not only getting bigger, but it is also becoming more diverse. In the chart below, notice how the share of investment into “other” industries has increased from about 10% in 2011 to a peak of 30% in 2018. Given that $131 billion was invested in 2018 versus just $45 billion in 2011, that means roughly $40 billion was invested in non-traditional sectors in 2018 versus just $5 billion in 2011. In addition, software has fallen from its peak of nearly 40% in 2014 to just above 30% in 2019.

U.S. VC Deals by Sector

There have been two other significant changes in the industry in the past few years. First, companies are staying private for longer, which not only enables VC investors to capture more pre-IPO value, but also allows startups more runway to prove their business model and solidify their revenues. At the same time, the industry is moving toward more “mega” rounds, which are funding events in excess of $100M. These huge investments have contributed to the proliferation of so-called “unicorns,” venture backed firms valued at more than $1 billion.