VC Investments & Startups in the US

  • • What VC investment activity looked like in the US in 2018

2018 witnessed the highest investment in the US startup space by venture capital firms since the days of the dot-com boom. The shape of the VC investment landscape is changing. VC’s are investing in a similar, if slightly reduced, number of deals. 2018 recorded a 5.7% decrease in the number of VC deals invested overall compared to 2017. Particularly, investments into companies at the angel and seed phase of fundraising dropped off significantly, falling 16.8% in total number of deals at that size. But while the number of deals closed dropped, the dollar amount invested by VC’s rose significantly as investors invested more and more into deals in the $50M+ range. These facts imply an increasingly more mature startup space as investors focus on more established companies with a track record of profitability and proven business models. Unicorns (companies valued at $1B+) did particularly well this year, closing 120 deals and raising $44.5B in the process. Total VC investment in the US for 2018 was $130.9B, the first time that VC investment surpassed the $100B mark since the year 2000 ($105B in VC investment that year). Sector by sector analysis of investments reveals interesting trends as well. Software remains the sector with the highest investment, with investment of $46.8B in 2018. The pharma and biotech sector hit an all-time high in 2018, raising almost $17.4B.

Early- and late-stage VC investments have driven the sharp rise in VC investment. Particularly, late-stage investments in the $50M+ range have witnessed a dramatically higher investment. In 2017, they made up 61% of all late-stage investments and totaled $28.77B. Those numbers increased to 76% and $63.25B in 2018. Total investment into $50M+ deals in 2017 became a more significant part of the total US VC investment, going from $36.8B and 44.4% in 2017 to $81.1B and 61.9% in 2018.

An increasing trend in 2018 was the rise of new exit modes. VC’s eschewed seeking IPO’s in favor of their companies being acquired by one of its other competitors or through buybacks by the management. Buyouts are increasingly becoming more popular, representing close to 20.2% of all VC exits in 2018 compared to 12.2% in 2016. Meanwhile, the share of exits through acquisitions dropped from 82.8% to 69.9% over the same period. That said, the actual value of exits continues to be dominated by acquisitions and IPO’s, with buyouts an afterthought in the process. Thus, acquisitions and IPO’s remain the main avenue through which VC’s successfully exit from their investments. The share of the number of buybacks seems to imply a higher rate of companies that do not necessarily fail but do not produce VCs’ desired returns.

Figure 1 – US VC activity by number of deals and $B invested – 4Q 2018 Pitchbook-NVCA Venture Monitor (Link)

The geographic profile of VC deals in the US has not changed over the past few years. The majority of deals are concentrated on the west coast (40% in 2018) and “Mid-Atlantic” region (which includes New York and Washington DC; 20% in 2018) [1]. San Francisco, as expected, is the top city for attracting VC investment, having 33% of total US VC investment in 2017. New York City comes in second, receiving 16% of VC investment in 2017 [2]. The concentration of startups in those regions has had both its advantages and disadvantages which we will discuss further down in the report.

  • Some issues startups face in the US
    • Immigration

The backlash in the US against immigration, whether skilled or unskilled, may have severe repercussions for startup investment in the country. Given that 43% of the Fortune 500 companies were founded by either immigrants or children of immigrants [3], it is easy to see how immigration contributes to the economic growth and prosperity of the countries that receive it, including the US. In the US, foreign-born individuals hold 40% of master’s degrees in the fields of science, technology, engineering, and math (the so-called STEM fields) and more than half of all PhD degrees in those fields [4]. Furthermore, the “startup visa” initiative, passed late in the Obama presidency, has been effectively killed under the Trump administration [5]. The Trump administration is also seeking further cuts to legal immigration, presumably including the H-1B visas that allowed many corporations to bring skilled workers into its US headquarters with relative ease compared to the rest of the American immigration system. Should the general hostility of the Trump administration towards immigration continue, this will be a headwind for the US startup scene and could spell trouble as more and more workers head to other parts of the world where the tech industry is thriving. As per our previous reports, one such place is Canada, which provides several advantages. Those include proximity to the US, similar regulatory and business environment, and a much more welcoming immigration system, especially to skilled workers. Canada even has its own version of the startup visa program.

Figure 2 – Unicorn Deal Activity – 4Q 2018 Pitchbook-NVCA Venture Monitor (Link)

    • Regulation

Despite most American startups being small enough to only operate in the US or North America, the global nature of the modern business landscape means that startups are increasingly running up against regulations of other jurisdictions. For example, rather broadly, it was found that 52% of all US companies possess data pertaining to EU citizens, making those companies subject to the EU’s General Data Protection Regulation (GDPR). Startups that operate in the EU will be subject to these rules as well. Similarly, companies that operate in highly regulated industries will become increasingly subject to rules that affect their more established competitors. One such group of companies is FinTech companies, which operate in an industry where there are plenty of laws and regulations that govern how companies should operate and what they may or may not do. FinTech companies have to consider how to address functions of business such as regulatory compliance (for example, KYC and other AML procedures) that pose a significant but necessary cost on traditional financial services companies.

Startup exposure to regulations has also led to the rise of RegTech: companies that aim to use technology to streamline regulatory compliance functions for their clients. Such companies work by either enacting compliance procedures themselves or making sure their clients’ procedures are adequate. Given that compliance is a serious issue that requires resources and investment by different companies, businesses that can take on outsourced work or reduce it will be of great value in the modern business environment [6].

    • Location

As seen previously, startups in the US are concentrated in specific regions that have historically given rise to startups as well. This is due to several reasons. Startups tend to situate themselves in major cities to draw on a large talent pool. Locating near a city also provides an extra incentive for companies to attract new workers, as potential employees (which in these companies tend to be young) are more likely to move to what they perceive as cosmopolitan cities. Furthermore, venture capital firms and other startups have already established a network in cities like New York, Boston, and San Francisco. Thus agglomeration effects start to make moving nearby a more appealing prospect. If potential investors and customers of your services are concentrated in one area, it makes sense to move to that area as well. Cities tend to have a more educated population which is the type of workers that are needed by most startups. Many cities are also homes to major universities and the collaboration possible between high tech startups and research departments in universities leads to more innovation.

While this concentration is, of course, positive and leads to further collaboration and reduced costs, it also poses several challenges to policymakers. For one, an explosion of growth in both economic activity and population places a strain on the infrastructure of the cities experiencing this growth. Inadequate infrastructure, be it housing, transit, or something else entirely, leads to lower potential growth. Cities in North America are experiencing increased housing prices, likely due to the supply of housing not keeping up with the number of people who are moving in. Transit projects are another issue that are affected by movement to cities. The process of upgrading and repairing an existing transit system is a significant challenge to the well-functioning of a city. Placing it under pressure leads to reduced growth. 

The concentration of new startups has pushed some jurisdictions in the country to attempt to offer incentives to attract new businesses to locate their offices in those jurisdictions. This is exemplified by the Amazon HQ2 competition which saw many cities offer various policy, infrastructure, and tax incentives in an attempt to woo Amazon. Policymakers should be very careful in offering such incentives to businesses as regulatory competition has had negative effects for all jurisdictions involved in the past. 

  • The most important trends startups will face in 2019
    • Disruptions in FinTech and healthcare

FinTech is one of the areas that has seen the rise of many companies aimed at streamlining old business processes and reducing costs. As traditional financial services companies such as retail and wholesale banks continue to modernize their technology and infrastructure, they are increasingly viewing themselves as technology companies. This means a greater potential for collaboration among those traditional companies and the FinTech newcomers. Recently passed open banking rules in the EU have made it imperative for banks to allow third-party access to customer data if the customers approve of such usage. All signs point to similar regulations being in the works in the rest of the world. This will help drive innovation in how traditional banking services are offered. Related to that, payment companies are facilitating the process of allowing consumers to complete transactions via digital means. This area of the industry may be a potential foothold for traditional technology companies (such as Google and Apple) to gain entry into the sector. Through apps like Android Pay and Apple Pay, large tech companies are expanding into a completely different industry.

Figure 3 – VC Investment in $B by Sector – 4Q 2018 Pitchbook-NVCA Venture Monitor (Link)

Healthcare is one of the highest costs for individuals, insurers, and governments. Disruptions that aim to improve service or cut costs are thus showered with great interest. Some of these disruptions are very simple. For example, several companies such as Talk space and Lyra Health aim to match those seeking mental health help with mental health providers. Other companies in the space are more cutting edge. Genomic healthcare companies seek to study and sequence patients’ DNA to offer personalized healthcare services. Some are more well-known and cater to retail users such as 23andme, which beyond its ancestry predictions offers advice regarding possible health complications that a patient may be genetically susceptible to. Others are focused on helping doctors and other healthcare providers find and offer more personalized healthcare for their patients. An example of this is Foundation Medicine, which studies cancer patients’ DNA and recommends different existing treatment plans that may be best suited for the patient in particular. One thing is for sure: healthcare startups have the potential to upend how we approach healthcare and potentially lead to vast improvements in quality of care.

    • Artificial Intelligence

The use of artificial intelligence algorithms has mushroomed over the past few years as companies are finding more uses for the technology and transforming their businesses. The role of AI, while sometimes overstated, has been integral to the business landscape, as every company and trend that we have discussed in this report so far has been influenced in some way by the transformative power of AI. Fortune 500 companies are using algorithms to target customers better, predict product usage, and find new ways to do old product offerings in ways that may be easier for the consumer, at a reduced cost to themselves or the customer, or both. Newer companies are using the power of AI to offer wholly new products to customers, whether retail or businesses. As Ajay Agarwal, Avi Goldfarb, and Joshua Gans in their book “Prediction Machines” describe it, AI at its core allows those who use it to make better predictions. Predictions are never perfect, and thus there are limits to what AI can do, even if its power and potential are revolutionary. True artificial intelligence that attains consciousness, if even possible, is still many years away.

    • Data and Privacy

Data breaches over the past few years have underscored the importance of cybersecurity as technology continues to make its way into more parts of our lives. Regulations such as GDPR in the EU and the HIPAA privacy rule in the US require compliance in how businesses store, access, and use customer data. As more vital data about consumers moves into digital storage, the possible risk and potential losses from data breaches will grow, and requirements for data protection will only increase. Many new startups are thus able to provide value to privacy-minded customers. Companies like Cybereason and Zeguro use AI to monitor possible security threats for clients and detect digital security weaknesses.

Source from: MERatings