19 April, 2013

• VC investment fell to its lowest level since 2009 in 2012
• VC-backed IPOs and M&A exits down, but speed to exit is up
• VC model is realigning to invest less, later and on tougher terms

London,19April 2013– Widespread economic uncertainty and a tough exit environment saw venture capital (VC) investment fall 20% to $US41.5b and the number of rounds decline 8% to 4,970 in 2012, according to Ernst & Young’s Tenth annual venture capital insights and trends report. Average round size also decreased to US$8.4m. Mirroring the trends in investment, the total number of VC funds closed down 13% to 280 from 323 in 2011 and the value closed down 31% at US$29b.

Investments were down in all markets and the amount of financing in the seed and first round stages dropped across all regions. The US and Europe continued to dominate – accounting for 85% of global investment.

Maria Pinelli, Global Vice Chair, Strategic Growth Markets at Ernst & Young comments: “2012 was a tough year for global venture capital and we saw consolidation in the market as the number of active investors declined. However, we are hopeful that 2013 will see the industry turn the corner. Steadying economic conditions will bolster investor confidence and point towards a strengthening risk appetite.”

Number of exits down

The number of VC-backed IPOs and M&A exits were down in 2012. The amount raised via IPO declined globally by 27% from US$22.1b in 2011 to US$16.1b in 2012. At the same time, VC-backed M&A activity declined by more than 20% to 618 deals.

Maria Pinelli comments: “Speeding the time to exit will help VC funds return capital to their investors, show a successful track record and get them started on the process of opening, raising and closing new funds. IPOs are still the most lucrative exit vehicle and, as post-IPO performances are increasingly important, trends point towards VCs retaining a portion of their investment post-IPOs.”

VC model is realigning

VC funds are adjusting their investing strategies in favor of later stage companies. Globally, the share of investment directed at revenue-generative companies increased to 69% in terms of the number of deals (from 56% pre crisis in 2006) and 74% in value terms. Angel investors stepped in to fill the gap in start-up stages left by VC.

Maria Pinelli comments: “We see evidence of money flowing into companies that are perceived as less of a high-risk. There is a shift away from social media towards enterprise. Companies that are attracting greater VC interest are providing a service and getting paid for it. This trend toward later and smaller investments in less risky companies is being accompanied by a move to tougher terms.”

Increasing role of corporate venture

Corporate venture investing is rising and surpassed pre-dotcom levels in 2012. Corporates are keen to invest in and acquire venture-backed companies to fill the in the gaps in their strategy and innovation capability.

Corporate venture investments, which tend to be focused in the US on later stage businesses, generally have a positive impact. The valuation of the business in that round is typically greater than in companies at a similar stage with no corporate investor – the median valuation premium over the last decade has been 54% in the US.

VC trends by market

US: US VC investment activity declined by 15% to US$29.7b in 2012 compared to 2011. The number of investment rounds also fell, but the drop was not as pronounced, declining by 4% to 3,363. As of January 2013, US$168b was invested in 8,288 companies.

Maria Pinelli comments, “The exit environment will be crucial for the US VC industry outlook in 2013. Equity markets have started the year positively, but considerable uncertainty remains regarding the resolution of the US budget, which could have an adverse impact on sentiment.”

Europe: Reflecting the global trend, European VC investments declined by 16% year-on-year to US$5.7b, while the number of VC investment rounds declined by 11% to 1,074. Within the overall total there was a shift towards later-stage investment, with the proportion of deals in the generating revenue stage rising from 68% in 2011 to 74% in 2012, while product development deals fell from 21% to 18%. Maria Pinelli says: “Looking ahead to the remainder of 2013, with European growth expected to remain very subdued and with the trend towards tighter regulation firmly in place, the contraction in VC investment activity in the region is likely to continue.”

China: VC activity dropped from the record levels of 2011. In 2012, US$3.7b was invested in 202 rounds, a year-on-year decrease of around 40% for both figures. Despite this, the median value, at US$10m, was significantly higher than that in other parts of the world, due to substantial investments in profitable companies. Beijing, one of the emerging hotbeds, attracted a significant amount of VC investment through relatively fewer deals. At US$19.9m, the average round size in Beijing is the highest and well above the global average of US$8.4m.Maria Pinelli continues: “We expect the VC market to rebound in the second half of 2013. Although growth will be steady, we do not anticipate a return to the heights of recent years.”

India: India bucked the declining global trend in VC investment activity in 2012. The number of investment rounds increased by 17% to 205, the third successive year of increasing activity. The growth of India’s investor community and the resulting increase in the amount of capital being invested in domestic opportunities provides India’s VC industry with a degree of insulation from global shocks, and the outlook for the coming year is positive.

Looking ahead

Maria Pinelli concludes: “It’s worth remembering over half of today’s Fortune 500 were created in a downturn so not surprisingly competition for high quality deals is fierce. VCs are competing with each other and with other sources of capital. Establishing a robust VC value proposition for investee companies is a must-do strategy.

“We expect 2013 to be a better year. Early signs suggest better exit prospects – a pre-condition for increased fund-raising and a more supportive environment for the sector.”