New rules for venture capital?

Analysts see lower first financings as a sign that start-up valuations are peaking and the funding of new ones is tapering off. While some see the peak of the VC investment cycle, other just see new rules for the industry.

According to PitchBook Data Inc., the number of first financings was down to 1,983 deal as of December 1. Measuring the very first round of professional funding for start-ups, the index fell from 3,368 for the full year of 2014. The amount invested in those financing rounds fell to $7.5 billion in 2014 to $6.01 billion in the first eleven months of 2015.

Besides a decrease in first financing, the PitchBook report sees a slowdown in exits as another thread to the VC industry. Compared to 2014 with exits worth $93.77 billion on 994 deals, exists in 2015 so far amount to only $64 billion on 860 deals. The drop in first financing “indicates that the future crop of VC-backed companies will be weaker than we’re used to seeing,” Daniel Cook, analyst at PitchBook said to the L.A. Times. “Exists are down dramatically, and the public markets are in limbo.”

Although some investors are refraining from riskier assets as John Lonski, chief economist for Moody’s Analytics, argues, investors are pushing money into venture capital funds. Until the end of November, investors put $37 billion into VC funds. During the full last year, only $34 billion were invested.

Some start-ups could not hold the high valuations that investors have previously imposed on them. Steven N. Kaplan, finance professor at the University of Chicago, said that 2014 and 2015 mark a period of start-up valuations that was bound to taper off. The rapidly rise in the number of unicorns, start-ups valued higher than $1 billion, is coming to an end, he said.

This is in align with research suggesting that the VC industry is at a turning point. According to a study pursued by Cambridge Associates, the rules in the venture capital industry have changes over the past years. The study shows that venture capital investments need to be more diversified by now.
The rule of “only 10 venture investments each year matter” has been debunked as by now, 60 percent of returns were generated by investments outside of the 10 largest outcomes. Moreover, between 40% and 70% of value was created by new and emerging VC managers and 20% of returns came from outside the usual VC hubs including California, New York and Massachusetts. With value being created further down the tail, manager need to make more investments each year, conclude Alan Patricof, cofounder and managing director of Gerycroft Partners, and Ian Sigalow, partner and cofounder of Gerycroft Partners, on Business Insider.