News | 06.04.10

Murky Megarounds

With venture capital hobbled by recession and the credit crisis, many startups have been struggling. So how do you explain seven startups that have successfully raised rounds of more than $100 million apiece this year so far, including two early-stage startups, Groupon Inc. and Amonix Inc.? Does this suggest that a recovery is afoot? Or that a bubble is brewing?

It is hard to make a case for a bubble given the data. But what these deals illustrate is how venture capitalists, in the aftermath of the credit crisis, are changing the way that they invest.

Such large venture rounds are not entirely unusual, but this year does indicate an increase. Last year saw four such rounds, 2008 had five, and 2007 had six, according to The Deal Pipeline’s VC Deal database.

At the time, observers attributed the megarounds to a shift toward late-stage fundings starting in 2006, anticipating the recession. But the numbers don’t necessarily show such a continuing trend. While volume of late-stage fundings jumped 17% from 2006 to 2007, late-stage deals went flat from 2007 to 2008, then fell almost 33% between 2008 and 2009, according to figures from the National Venture Capital Association.

In fact, the data on average round size suggests a subtle shift toward a focus on early-stage, not late-stage, startups. Between 2006 and 2008, average deal size for both early- and late-stage startups remained stagnant until 2009, when early-stage round sizes jumped. The average seed round in 2009 ran about $5 million, versus $3.3 million in 2008 and for the previous three years, according to the NVCA. A similar but less dramatic trend also played out in early-stage financings. Meanwhile, expansion and later-stage rounds saw a sharp decline in average size.

“I think there’s funny phenomena right now where traditional B rounds are hard to come by, so VCs are trying to fund startups through to later-stage rounds,” says Nat Goldhaber, managing director of Claremont Creek Ventures.

In the past, A rounds funded prototype building, B rounds fueled beta testing, and C rounds financed marketing, says Goldhaber. Over the past few years, the beta-testing phase became part of the A round, and B rounds began supporting marketing, he adds.

FirstMark Capital LLC managing director Amish Jani agrees, noting that new tools like cloud computing make it possible to quickly build businesses. “Today’s startups are standing on the shoulders of giants,” he says.

VCs are interpreting the spate of megarounds as a sign that it will take longer than usual to reach liquidity, says Paul Hurdlow, co-chairman of the emerging growth and venture capital practice at DLA Piper US LLP. A recent survey by the firm showed that 62% of tech leaders and VCs believe the fundamental model for building tech companies has changed and the majority project that VC-backed companies will take longer to achieve liquidity.

Despite concerns over exits, there are glimmers of hope. A few venture-backed initial public offerings have made it out the door this year, including battery maker A123 Systems Inc., online advertising firm ReachLocal Inc. and online marketing firm QuinStreet Inc. They built on last year’s successful debuts of VC-backed Fortinet Inc., OpenTable Inc., LogMeIn Inc., SolarWinds Inc. and Medidata Solutions Inc. The DLA Piper survey showed that 73% of respondents believed the IPO market for VC-backed companies would rebound in 2010.

Nonetheless, venture capitalists appear to be girding for longer incubation periods and may be putting more money up front. “What’s driving larger early-stage deals is liquidity,” says Hurdlow. “Liquidity is the most fundamental driver of funding.”

That concern over liquidity could explain the deal Yelp Inc., whose website allows users to review local businesses, struck earlier in the year with Elevation Partners. When the private equity firm invested $25 million in the social media startup, Elevation agreed to commit up to $100 million more for future needs.

Such large rounds will make selling more difficult. Large rounds occur nearly exclusively at companies that VCs have identified as 800-pound gorillas — say, a Google Inc. — and that they expect to take public, notes NVCA president Mark Heeson. “It is difficult to see an acquisition route for these startups without a buyer paying a large premium.”

But the IPO route can be limiting. “Committing capital to only an IPO could be disastrous,” says Bob Ackerman, a managing director at Allegis Capital. “I can’t say what the public market will look like in five or six years.”

Groupon, a Chicago-based hyperlocal e-commerce startup that raised $135 million, fits into that category. The company serves more than 50 cities, with discounts to restaurants, bakeries and hair salons, while its largest rival, LivingSocial, hits only 18 cities, and a third, BuyWithMe Inc., operates in four. For every deal sold, Groupon receives a cut; it has reportedly generated $350 million in revenue. Groupon requires boots on the ground to sell in each city, forcing it to amass enough capital to staff up ahead of rivals and revenue.

The last time e-commerce and new media startups like Groupon and Yelp were top fundraisers was the dot-com era. “What’s different this time around is a knowledge of what’s viable,” says Hurdlow. “Revenue models are now understood, meaning people have a better idea of how to value a company.”

Ackerman suggests that the valuations for social networking startups are getting frothy, but other sectors like storage, mobile communications, security and even cloud computing are more reasonable.

Megarounds appear to be absorbing a larger piece of the pie as overall investing shrinks. Venture investments nationwide rebounded modestly in the second half of 2009, according to the PricewaterhouseCoopers MoneyTree Report. But the annual total of $17.7 billion was a steep falloff from $28 billion in venture investments in 2008 and $30.5 billion in 2007.

Cleantech has been the largest beneficiary of megarounds, contributing four of the seven financings this year. Green startups include Amonix, a maker of concentrated photovoltaic solar power systems that raised $129 million; Better Place Inc., which raised the largest round with a $350 million financing for electric-car-charging stations; BrightSource Energy Inc., which raised $150 million to build solar energy plants for utilities; and Fisker Automotive Inc., which raised $115 million to launch its plug-in hybrid sports car.

(Also attracting megarounds were Aircell LLC, which picked up $175 million to install Wi-Fi on commercial airliners, and ExteNet Systems Inc., which raised $128 million to build a wireless network to lease to cellular carriers.)

What most of these startups have in common is a capital-intensive business model. What sets Amonix and Groupon apart are their relatively early-stage nature — although FirstMark’s Jani denies that age is relevant. Both are only two years old, whereas the youngest of the other companies with 2010 megarounds, Better Place, is more than three years old and the oldest, Extenet, is eight. But similarities between Amonix and Groupon are limited. Groupon is generating revenue, but Amonix is still losing money.

Spurring investments in greentech is government funding. “Government stimulus is offering low-cost leverage to cleantech startups,” says Hurdlow.

Both Fisker and Amonix are eligible to receive Department of Energy loans. The only way to access those loans, however, is to be highly capitalized. Fisker’s large round came ahead of a $527 million DOE loan commitment. Amonix received $9.5 million in stimulus funding as part of the federal Reinvestment and Recovery Act’s Advanced Energy Manufacturing Tax Credit.

How long will this situation last? As long as exits are limited. “Hopefully, we’re seeing the end of the recession. If we are indeed seeing a global stabilization, we’ll soon see a commensurate rise in M&A activity and, eventually, IPOs,” says Goldhaber.


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