IVCA Feature: Highlights of IVCA Luncheon on Earlier Growth Stage Financings and Implications for PE & VC Firms

November 13, 2019

• Sach Chitnis, Founder & Managing Partner of Jump Capital
• Constance Freedman, Founder & Managing Partner of Moderne Ventures
• Jamison Hill, Senior Principal of Bain Capital Ventures
• Jim Macdonald, Managing Director of First Analysis

As competition heats up in the PE and VC world, financing rounds in Seed & Early funding rounds are are becoming bigger earlier in companies’ life cycles. Investors have to be very disciplined and thoughtful about where and whether to place bets. 

See event pictures here!
 
The four panelists took questions on this phenomenon from moderator Ira Weiss, and here are the essential highlights of their answers.
 
QUESTION: Jamison Hill, when do later stage funds want to get involved in earlier stages?
Hill mentioned that one thing trending that Bain started to see, around 2014-15, that in Series C funding for a successful company the devaluations were beginning to outpace the revenue traction. Add factors like low interest capital, companies staying private longer and new players like SoftBank, these factors have made the growth stage financing come earlier and earlier. Well-performing companies in Series A, even over just one quarter, has caused valuations to rise substantially.
 
Putting it all together, the primary motivation for later stage funds moving earlier is how the market is now, that waiting for potential funding often gets to be too late because of high valuations and inside investors not allowing outside interest. Firms almost have to play earlier.

QUESTION: For Sach Chitnis, how do you see that earlier funding playing out in your firm’s dynamic?
Chitnis pointed out that when Jump Capital began in comparison to today, they were around 80% Series B & C when they started, and today they are 80% Series F. They are writing the same check size, they are going to market in the same manner and today they’re investing in a totally different profile of business.

Using Chicago entrepreneurs as an example, Chitnis expressed that seven years ago the confidence was lacking that additional series of funding would come after the initial stages. Today, there are more outside firms investing in Chicago businesses, and the confidence that coastal firms will come here and see value, has allowed the entrepreneurs to burn more, be more aggressive and take more money.
 
From a Jump Capital perspective, successful companies are drawing more fund competition, but there are others who are doing well but not getting funding notice. We help with operations in those companies, and then the coastal companies become more aggressive in funding. So, there are no problems finding operational help and money.

QUESTION: For Jim Macdonald, with so much money sloshing around in the market, how does that impact how we invest, when assessing potential investments?
Macdonald began with first, it’s understanding the market that they are in … at First Analysis, they’re not generalists, they are specialists. One of their portfolio companies is Yello – which is in HR Tech – and they began that with a moderate initial investment and nurtured the company as it increased in value.
 
Well, Yello is in nice spot right now, according to Macdonald, because suddenly HR Tech is very hot, and companies with no track records are getting high dollar funding. They have to figure out how to compete with that kind of marketplace. The no-track-record companies that are getting the high dollar funding are going to do something with it, so First Analysis had to figure out how to navigate that eventuality.
 
Jamison Hill added that one of the hallmarks of San Francisco investing it that companies use capital as a weapon. Part of any business strategy is a fundraising strategy, and the big checks get the big headlines. Bain is seeing companies that are being funded 100 times above their Average Order Revenue (AOR). There are investors willing to do that, and it’s about getting your ownership established. Hill also mentioned the “bottoms-up” model, which supposes the idea can generate income in the hundreds of millions with the right initial cash infusion.
 
Constance Freedman talked under-the-radar investments like ICON, a company that uses a method to 3-D “print” building materials that become homes … in 24 hours, they can print an 850 square foot home for four thousand dollars – which is a game changer – but it also has to be figured out, and needed a multi-million dollar initial investment. The point being that is at least it has a tangible, defensible product beyond an AOR spreadsheet. For investments, it comes back to sticking with a decent strategy for outcomes.
 
QUESTION: For Constance Freedman, what is Moderne Ventures model for raising capital at various stages?
 
Freedman noted that a lot of what Moderne Ventures does is seek tech solutions for companies who have no idea how to go about it … they become a de facto Venture arm for mature companies. In doing so, their network is 700 corporations/executives strong now, which is literally bringing our firm customers and partnerships. It’s a model of synergy. Plus,  they’re getting unique opportunities at the growth stages, in which a company wants to increase their scale. It might not have the same multiples, but it’s less risky, and returns come back much more quickly.
 
QUESTION: Back to Constance, amplify how corporate venture capital is changing the competitive market?
 
Freedman pointed out that corporate venture is always active in an upward cycle. So it’s back up again right now. However, when 50% of funding is from corporate VCs, it affects the overall venture market. Valuations are up, and companies who stay private can actually fund large initial rounds. It also has changed exit strategies … there can be a pricing out of what corporate venture can pay. It keeps entrepreneurs more grounded and thinking about an endgame.
 
QUESTION: We’re seeing some firms expanding into dedicated seed strategies. How do those strategies impact seed capital?
 
Sach Chitnis sees a negative bias. If he looks at a company and their seed round investor is not leading their Series A, it’s an indication that this option maybe didn’t play out the way they thought. From a Jump Capital perspective, they’ve had mixed results. They’ve had 6-10 seed investments since its inception, 3-4 had Jump leading the next round, and the others they didn’t, and the market thinks, ‘why isn’t Jump leading the next round?’ The optics need to be considered. Jamison Hill added it skewers all the pricing, and puts too much pressure at the seed fund level.
 
QUESTION: What is the impact of SoftBank [Japanese conglomerate and investment firm, who operates a competition-killing $100B fund]?
 
Jim Macdonald opines that everyone is affected by SoftBank, having to do something different because of the firm’s impact. Constance Freedman added that if SoftBank gets into a space, then the whole market in that space gets skewed. Time will tell if that has ramifications. Sach Chitnis brought up SoftBank’s recent purchase of a parking space operator, and how everyone in that space was affected. Jamison Hill observed that SoftBank invests so far beyond where it is that nothing else matters. But also he points out that massive cash infusions don’t necessarily mean successful management of companies and products.
 
QUESTION: What about Private Equity in this these scenarios and markets?
 
Jim Macdonald talks about First Analysis selling several of their companies, and he sees Private Equity willing to pay higher multiples. It’s changing the exit market. Sach Chitnis see PE buying companies with not much EBITDA, and producing surprising liquidity. With excessive cash in the PE industry, supply and demand is out of whack. The competitiveness is in the $100-$400M enterprise value, with $800B out there, that the criteria for companies the firms are looking at is diminishing over time.
 
QUESTION: How are high valuations affecting risk in PE portfolio companies?
 
Jim Macdonald observes that the higher the funds raised, the more absurd the final exit price must become, just to have a half decent return. That eliminates likely sales and is predicated now on a super sale. There is potential self-destruction for companies who do high funded rounds because they can’t get to the exit an investor needs.
 
Jamison Hill mentioned that there is less risk at growth stages, because companies have figured out some scalable pursuits for their product or service.
 
AUDIENCE QUESTION: Do you see any vertical niches that corporate’s innovation groups are giving up on and just saying, ‘I gotta go buy it’ because they can’t compete?
 
Constance Freedman quipped ‘all of them?’ She explained that corporate cultures are so resistant to change, that it would seem to be in their best interests to invest outside the company. When they see the changes happening in their core industries, they won’t do that change internally, but invest in an entity who can do the change. Jamison Hill added that corporate view disruptions in their core as a wake-up call, and the good news is they have extensive customer data. They catch on disruptive trends, and scale what they invest in. Freedman interjected that if the corporates do nothing, they are simply leaving too much value on the table.
 
AUDIENCE QUESTION: How has intense investment competitive affected term sheets?
 
Jamison Hill said, ‘Our term sheets have gone from 10 pages to one.’ Sach Chitnis joked ‘they are no longer term sheets, they’re just sheets.’ The West Coast is changing term sheets, eschewing even NVCA industry standards. It’s a new version of “founder friendly.” Constance Freedman said it’s happening at other stages as well.
 
AUDIENCE QUESTION: With the market changing and competition intensifying, how are the ROI expectations for LPs changing?
 
Sach Chitnis mentioned that the medium ROI is at 13%, with the top figures at +20%. The last five years been strong for venture, with 25% not unusual. Jamison Hill said that venture is very attractive presently, but was less optimistic, especially as series platforms and operations are established. 

The IVCA Annual Awards Dinner will be December 9th, 2019, presented by Kirkland and Ellis LLP, at the Four Seasons Hotel in Chicago. For more information, including tables/tickets to the event, click here.