The received wisdom in Silicon Valley is that raising more capital in larger and larger rounds is an essential part of the formula for success. But is this idea supported in the data?
When looking at the world of tech startups, there has been a clear trend toward more and more jumbo-size financings.
In what might be called foie gras’ing, the number of rounds sized $100M and above to US startups nearly tripled between 2016 and 2018.
Investors of various types have fueled this trend, including hedge funds, sovereign wealth funds, mutual funds, and other asset managers.
But SoftBank Group’s Vision Fund in particular has come to embody this new normal.
The fund, with over $100B in capital, has rained money on startups across categories, from real estate (WeWork and OpenDoor Labs) to insurance (Lemonade) to bioengineering (Zymergen). SoftBank’s stake in Uber was an eye-popping $7.7B (pre-IPO) bet.
As Softbank and others plunged in, $100M+ mega-rounds became allmost routine.
“Rather than having [SoftBank’s] capital cannon facing me, I’d rather have their capital cannon behind me, all right?”
—Uber CEO Dara Khosrowshahi
Meanwhile, traditional VC funds are getting bigger and bigger, feeding into this cycle of capital abundance and lavishly funded startups.
Leading VCs Sequoia Capital, New Enterprise Associates, and Accel have all announced record $2B+ funds in the last 12 months. Sequoia’s new $8B fund will be 4x larger than its previous biggest-ever vehicle.
To better understand whether Silicon Valley’s capital enthusiasm is grounded in reality, we used CB Insights data to analyze more than 500 VC-backed US tech companies that have seen $100M+ exits since 2013.
We compared low-raisers (less than $100M in VC) and high-raisers ($100M+) in terms of their valuation at M&A, as well as their performance at IPO, shortly after, and over the long term.
- After IPO, the most highly funded startups tend to underperform those who raised less.
- In fact, the companies that raised the most almost uniformly struggled to create long-term growth.
- Plenty of companies that raised <$100M have seen top exits.
- The biggest exits, backed by the deepest-pocketed investors, are returning less and less as foie gras’ing becomes more common — and more extreme.
- Exceptions like Facebook (both lavishly funded and successful) tend to get most of the attention due to survivorship bias.
Read on for a deeper analysis.
How raising money affects long-term company performance
Silicon Valley has many success stories involving companies that raised relatively little.
WhatsApp, Veeva, Fitbit, Chewy, Nest Labs, Palo Alto Networks, Arista Networks — all achieved big exit valuations with a fraction of the capital raised by companies like Jet.com or Zayo.
To get a long-term perspective on how these two kinds of companies performed, we took a low-raise ($100M in total funding or less) and high-raise ($100M+) cohort and analyzed their short- and long-term stock performance.
Overall, low raisers outperformed high raisers, and saw a median increase in post-IPO value of 263% — compared to an only 64% median increase for high raisers.
For example, 6 out of the 11 highest valued high-raise companies — Snap, Groupon, Dropbox, Zynga, Lending Club, and GreenSky — have registered a negative change in value since their IPO. For companies that have seen an uptick in value, growth has been limited: Twitter and Zayo Group Holdings have seen growth of less than 100%, while DocuSign has only done slightly better.
But among the low-raise cohort, it’s a different story.
Six of the 9 most highly valued startups at IPO that raised less than $100M — Veeva Systems, Palo Alto Networks, ServiceNow, Tableau Software, Splunk, and Ubiquiti Networks — have tripled their valuations since going public. ServiceNow’s value has increased nearly 1,900%, while Ubiquiti Networks’ has increased roughly 800%.
Low raise companies are relatively common in top exits
Given the assumption that more money equals bigger outcomes, you might expect to see a ranking of top tech exits be completely dominated by companies that raised hundreds of millions in funding.
But, among the 50 companies with the biggest exits since 2012, 32% raised just $100M or less.
This low raisers group includes companies like Veeva Systems, which went public at a $4.4B valuation with just $4M in equity funding — making its biggest investor Emergence Capital Partners a 300-fold return on investment.
It also includes WhatsApp, which raised only $60M before its $22B purchase by Facebook in what was the largest-ever acquisition of a VC-backed company at the time.
Most of the biggest IPOs, though, still belong to companies that raised large sums of money, Facebook being the biggest example.
The biggest exits are returning less and less
Today, it’s not just Sand Hill Road investing big in startups — it’s SoftBank with its $100B Vision Fund, sovereign wealth funds like Saudi Arabia’s Public Investment Fund, investors like Tiger Global Management, and banks like Goldman Sachs.
Despite writing sizable checks, these latecomers have not always been able to reap the huge returns of years past. While valuations are bigger than ever, multiples are not, because the biggest exits today are creating less value with the money.
One measure of how well a company is able to turn its investors’ capital into value for shareholders is the ratio of money invested into the startup to its valuation at exit — or the company’s efficiency.
Startups are highly efficient on this metric if they can take in little money on their way to a big exit — such as WhatsApp or an Atlassian. Less efficient companies, like Snapchat or Cloudera, raise large amounts of money but can’t produce a proportionate return.
Over the last few years, the amount of money being raised by startups in the US has grown to staggering highs. Exits have gotten larger too. But the capital efficiency of the huge tech exits has taken a big dip, especially since the relatively halcyon days of 2013-2014.
Since 2013, multiples are down among all exits from $100M to $1B+ in size, but the biggest exits have been hit the hardest.
Today, medium-large exits ($500M to $1B) have higher efficiency than $1B+ exits. They had an average return of 8.9x in 2018, just below their 2013 ratio of 9.7x.
However, the average multiple on $1B+ exits has fallen from 16.1x to 6.9x — a 57% drop in just 6 years. That’s the difference between a company that raised $500M selling for $8B and the same company selling for just $3.45B.
Overfunding is evident in the data
Among venture capitalists, asset managers, and startup founders, there has not been much questioning of the idea that more capital is always a great thing. And its proponents justify what they do by pointing to their most visible, public-end result: the eye-popping returns from companies like Facebook.
What gets lost in most analyses are the M&A deals that return a tiny multiple on money raised, or companies that take on hundreds of millions in venture capital and then perform badly post-IPO. The duds get passed over as the Silicon Valley myth is further burnished by outliers like Facebook.
Despite the exceptions to the rule, many companies out there do seem to be overfunded, including:
- SandRidge Energy ($3.6B at IPO, raised $870M)
- GreenSky ($4.3B at IPO, raised $610M)
- Zayo Group Holdings ($4.5B at IPO, raised $825M)
And this kind of overfunding is growing. A total of 12 of the top exits in 2018 raised more than $200M, compared to the 7 in 2017 and 3 in 2013.
The problem today is that more and more investors are getting in on the explosion of returns that technology has seen over the last decade. And at the same time, as institutional investors funnel unprecedented amounts of capital into the space, startups are showing signs of being unable to turn that capital intro greater value — with the worst effects at the top end of the spectrum.
The Silicon Valley love affair with mega-rounds needs reexamination. As much capital as possible and as quickly as possible is not only a bad formula for a great exit — it’s downright dangerous when viewed through the prism of long-term success in the public markets.If you aren’t already a client, sign up for a free trial to learn more about our platform.