2015 Venture Capital Report - WilmerHale

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Trends in VC-Backed Company M&A Deal Terms. Trends in .... Software. Other Life Sciences. Medical Devices. Biopharma
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wilmerhale.com Wilmer Cutler Pickering Hale and Dorr llp is a Delaware limited liability partnership. WilmerHale principal law offices: 60 State Street, Boston, Massachusetts 02109, +1 617 526 6000; 1875 Pennsylvania Avenue, NW, Washington, DC 20006, +1 202 663 6000. Our United Kingdom offices are operated under a separate Delaware limited liability partnership of solicitors and registered foreign lawyers authorized and regulated by the Solicitors Regulation Authority (SRA No. 287488). Our professional rules can be found at www.sra.org.uk/solicitors/code-of-conduct.page. A list of partners and their professional qualifications is available for inspection at our UK offices. In Beijing, we are registered to operate as a Foreign Law Firm Representative Office. This material is for general informational purposes only and does not represent our advice as to any particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome. © 2015 Wilmer Cutler Pickering Hale and Dorr llp

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2015 Venture Capital Report – Table of Contents 2

US Market Review and Outlook

6

Regional Market Review and Outlook

– California



– Mid-Atlantic







– Tri-State

New England

10

Selected WilmerHale Venture Capital Financings

12

Law Firm Rankings—Eastern US

14

European Market Review and Outlook

15

Law Firm Rankings—Europe

16

When Should I Incorporate My Startup?

17

Trends in VC-Backed Company M&A Deal Terms

18

Trends in Convertible Debt Terms

19

Trends in Venture Capital Financing Terms

20

WilmerHale Launch: Position Your Startup for Success

2 US Market Review and Outlook REVIEW In 2014, the venture capital market produced its strongest performance—in terms of both financing and liquidity activity—since the end of the dot-com boom. Deal flow approached its highest level since 2000, total venture capital financing proceeds soared to the secondhighest level in history, the median premoney valuation hit a record level, the number of VC-backed US issuer IPOs was the largest since 2000, and the median acquisition price for VC-backed companies was the highest since 2000. Both financing and liquidity prospects appear favorable for VC-backed companies in the coming year.

Equity Financing Activity The number of reported venture capital financing transactions dipped 4%, from 3,837 in 2013 to 3,682 in 2014—a decline that is almost certain to be erased once all 2014 deals are accounted for. Despite the normal lag in deal reporting, the tally for 2014 was the fourth-highest annual total since the collapse of the dot-com bubble in 2000. Once all 2014 deals are reported, the year’s result is likely to end up as the highest since the all-but-unapproachable total of 6,448 financings in 2000. The quarterly figures of 945, 995, 928 and 814 financings in 2014 are particularly encouraging in light of delayed reporting of some second-half transactions. Total reported venture capital financing proceeds leapt 47%, from $35.5 billion in 2013 to $52.1 billion in 2014. The 2014 tally was the highest since 2000 and 63% higher than the average of $32.0 billion in total annual proceeds over the preceding five years. The year’s total is likely to increase further after all 2014 financings have been reported. The amount of total proceeds in each of the four quarters of 2014 represented the highest quarterly total proceeds since 2000. The median size of all venture capital financings increased 34%, from $4.1 million in 2013 to $5.5 million in 2014—the highest figure since 2009. After declining over the preceding five years, the median size of first-round financings increased 19%, from $2.6 million in 2013 to $3.1 million in 2014. The general decline in the median size of

US Venture Capital Financings – 1996 to 2014 # of deals

$ in billions

6,448 92.9

4,645 49.2 2,588

2,212

1,912 9.9

1996

1998

2,298

21.9

17.8

13.0

1997

35.9 2,511

1999

2000

2001

2002

20.4

2003

2,463

3,110

2,859

2,618

3,100

34.5

31.1

2004

2005

2,794

36.4

2007

2008

2009

2010

2011

35.5

34.6

28.9

24.5

2006

3,682 52.1

3,204

33.4

25.0

23.6

3,837

3,785

3,683

3,381

2012

2013

2014

Source: Dow Jones VentureSource

Median Size of US Venture Capital Financings – 1996 to 2014 Life Sciences Technology All Financings $ millions 10.0 9.0

7.0

8.5 7.9

7.5 6.6

7.3 6.6

6.0 6.0

4.0 4.0

3.8 3.0

3.1

1996

4.5

5.0

4.5

6.2

6.5

6.0

6.5 6.0

7.1 7.0 6.5

7.0 6.2

7.2

7.5 6.7

8.0 7.0

7.5

7.5 6.8

6.5

5.0

5.0

4.7

5.0

3.6

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

5.4 4.5

4.0

4.3

2010

6.0

5.5

5.5 4.8

4.9 4.1

4.1

3.2

3.0

3.2

2011

2012

2013

2014

Source: Dow Jones VentureSource

first-round financings in recent years has been driven by reduced startup cash needs for many companies due to technological advances, as well as the desire of founders to minimize dilution. The median size of seed financings, which had fluctuated between $600,000 and $800,000 since 2005, increased to $1.0 million in 2014. The median size of second-round financings increased 8%, from $6.0 million in 2013 to $6.5 million in 2014, but fell short of the $8 million-plus figures that prevailed between 2005 and 2008. The median size of later-stage financings, which had remained at the $10.0 million level for three years, increased 30%, to $13.0 million in 2014—the highest level since 2000. The median financing size for life sciences companies increased 25%, from $6.0

million in 2013 to $7.5 million in 2014, matching the figure for 2008 and trailing only 2007’s $8.5 million figure as the sector’s highest median financing size since 2005. For technology companies, the median financing size increased 50%, from $3.2 million in 2013 to $4.8 million in 2014, reversing a five-year decline but remaining significantly lower than the median financing size during the ten-year period preceding 2009. The general decline in the median financing size for technology companies in recent years is at least partly attributable to technological advances that have enabled startups to commence and grow their operations with a lower level of funding than historically required—in many cases, cloud computing and open-source

US Market Review and Outlook 3 software have replaced the need to purchase expensive server racks, hire support staff and acquire costly software licenses. For the second consecutive year, the number of very large financings increased substantially. The number of financing rounds of at least $50 million jumped 69%, from 112 in 2013 to 189 in 2014, and the number of financing rounds of at least $100 million more than doubled from 28 to 62. These increases in super-sized rounds are partly due to the growing participation of private equity, crossover and hedge funds in venture capital financing. The largest venture financings of 2014 were completed by Uber ($1.8 billion and a separate financing for $1.2 billion), Magic Leap ($542 million), Snapchat ($486 million) and Airbnb ($475 million). The median pre-money valuation among all venture financings doubled from $20.0 million in 2013 to $40.0 million in 2014—an unprecedented year-over-year increase. The 2014 figure even exceeded the median pre-money valuations reached at the peak of the dot-com boom. This overall increase in 2014 was largely the result of a sharp increase in valuations for technology companies. The median premoney valuation in the technology sector nearly quadrupled from $12.0 million in 2013 to $45.3 million in 2014, leapfrogging the median pre-money valuation in the life sciences sector after trailing valuations in that sector for the past five years. Among life sciences companies, the median premoney valuation declined 18%, from $37.0 million in 2013 to $30.5 million in 2014. The number of reported seed and firstround venture capital equity financings declined, by 40% and 5% respectively, from 2013 to 2014. Seed and first-round financings accounted for 42% of all venture financings in 2014—down from 47% in each of the two preceding years. Proceeds from seed and first-round equity financings represented 15% of all venture capital financing proceeds in 2014, down from 20% in 2013. The average percentage of 19% represented by seed and first-round financings over the past five years is well short of the 32% average recorded during the 1996 to 2000 period. The decline in early-stage equity financings in recent years is partly attributable to the proliferation

Median Pre-Money Valuation in US Venture Capital Financings – 1996 to 2014 Life Sciences

Technology

All Financings

$

millions 45 40 37

30 25

12 12 11

1996

1997

25 21 20

18

18 17

15 14

13 14 13 13

1998

1999

31

29

2000

16

2001

18

16

15

14 11 11

10 10

2002

2003

19 19 18

24

22 21 18 18

20

23 22

25 20 20

18

20

25

22 22

20

19

15 15 12 12

2004

12

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: Dow Jones VentureSource

US Venture Capital Financings by Industry – 1996 to 2014 Biopharmaceuticals

Medical Devices

Life Sciences

Other Life Sciences

Software

Communications & Networking

Other Tech

3,489

Technology

2,235 1,922

1,076

1,265

1,395

1,327

495

536

566

652

1996

1997

1998

1999

856

2000

1,264

649

599

560

2001

2002

2003

1,324

1,289

1,269

589

664

715

756

1,076 1,160 1,082 1,012 966 944 798 759 853 770 758 748 766 731

2004

2005

2006

2007

2008

1,152

2009

2010

2011

2012

2013

2014

Source: Dow Jones VentureSource

of early-stage companies receiving smaller financing amounts and surviving on lower burn rates than historical norms. The decline in early-stage equity financings also reflects the growing influence of angel and super-angel investors and their preference for convertible debt financings, in which the company issues notes to the lenders-investors, with the notes converting into equity upon the closing of a subsequent financing, often at a discount and/or with other inducements for the lenders-investors. A variant on a convertible debt structure, called a SAFE (Simple Agreement for Future Equity) financing, has become particularly popular on the West Coast. A SAFE financing typically requires only one term to be negotiated—the cap on the conversion price—and only one legal document.

With 27% of all venture capital financing transactions in 2014, the business and financial services sector (which includes a number of tech-based companies) supplanted the technology sector for the largest market share in 2014. The technology sector accounted for 26% of the year’s transactions in 2014, compared to 28% in 2013. The market share for life sciences companies was 20% in 2014, the same as in 2013, after declining in each of the preceding three years. The consumer services sector also had a 20% market share in 2014. California—which has led the country in financing activity in each year since 1996 (the first year for which this data is available)—accounted for 44% of all venture financing transactions in 2014 (1,615 financings) and 55% of all proceeds

4 US Market Review and Outlook ($28.84 billion). New York, home to companies with 368 financings raising $4.64 billion in 2014, finished second in deal flow for the third year in a row, ahead of Massachusetts, which logged 283 financings raising $4.17 billion. Texas (with 138 financings raising $1.77 billion) and Washington (with 95 financings raising $1.09 billion) rounded out the top five positions for 2014.

Liquidity Activity With a boost from strong capital market conditions, the number of venture-backed US issuer IPOs increased 42%, from 72 in 2013 to 102 in 2014, continuing the recovery that began in 2010 after VC-backed IPOs had all but disappeared in 2008 and 2009. The year’s tally represented the highest number of VC-backed IPOs since 2000. The largest VC-backed IPO of 2014 was the $1.78 billion offering of JD.com, followed by the IPOs of Mobileye ($890 million), LendingClub ($870 million), King Digital Entertainment ($500 million) and GoPro ($427 million). After decreasing from 7.3 years in 2012 to 6.8 years in 2013, the median amount of time from initial funding to an IPO inched up to 6.9 years in 2014. In 2014, 63% of all VC-backed IPOs were by life sciences companies, up from 51% in 2013, while the VC-backed IPO market share for technology companies decreased from 49% to 34%. The median amount raised prior to an IPO declined 11%, from $100.9 million in 2013 to $89.6 million in 2014, and the median pre-IPO valuation decreased 25%, from $289.3 million to $216.7 million. As a result, the ratio of pre-IPO valuations to the median amount raised prior to an IPO by venture-backed companies going public fell for the third consecutive year, reaching 2.4:1 in 2014, compared to 2.9:1 in 2013 (a lower ratio means lower returns to pre-IPO investors). This ratio was between 3.2:1 and 5.5:1 for each year from 2001 to 2012, other than a spike to 9.0:1 in 2009 based on a very small sample size of VC-backed IPOs that year. In contrast, this ratio ranged from 7.5:1 to 10.0:1 from 1997 to 2000, due to very large pre-IPO valuations by younger companies. Reversing a three-year decline, the M&A market for venture-backed companies

Venture Capital–Backed IPOs and Median Time to IPO – 1996 to 2014 # of deals

Median time from initial equity funding to IPO (in years) 8.7

261

8.1

7.9 211

7.4

6.8

201 5.7

5.7

6.9

6.8

6.4

6.2 5.6

4.5 3.5

120 3.1 73

1996

1997

2.8

3.6

3.1

2.8

102 72

63

1998

1999

2000

25

20

23

2001

2002

2003

2004

43

48

2005

2006

72

2007

7

9

2008

2009

51

43

42

2010

2011

2012

2013

2014

Source: Dow Jones VentureSource and SEC filings The above chart is based on US IPOs by VC-backed US issuers.

Median Amount Raised Prior to IPO and Median Pre-IPO Valuation – 1996 to 2014 Median amount raised prior to IPO

$

Median pre-IPO valuation

millions

457 383

362

351 314

307 253

229

226

295

224

217

202

172

167

105

79 15

13

22

1996

1997

1998

289

238

31

1999

47

48

49

60

70

2000

2001

2002

2003

2004

51

57

65

2005

2006

2007

49

43

2008

2009

71

83

78

2010

2011

2012

101

2013

90

2014

Source: Dow Jones VentureSource

expanded in 2014. The number of reported acquisitions of VC-backed companies increased 8%, from 449 in 2013 to 483 in 2014, while total proceeds nearly doubled, increasing from $41.3 billion to $79.8 billion. Once all 2014 acquisitions are accounted for, the improvement in 2014 deal activity should be even greater. The median acquisition price for venturebacked companies increased 25%, from $50.0 million in 2013 to $75.0 million in 2014—the highest figure since 2000. After posting consecutive annual increases from 2001 to 2007, followed by consecutive annual declines through 2013, the median amount of time from initial funding to acquisition reversed course again, inching up from 5.0 years in 2013 to 5.1 years in 2014.

The median amount raised prior to acquisition increased 28%, from $11.3 million in 2013 to $14.5 million in 2014. The ratio of median acquisition price to median amount raised prior to acquisition increased from 4.4:1 in 2013 to 5.2:1 in 2014 (a higher ratio means higher returns to pre-acquisition investors). This ratio in 2014 was the highest annual figure since the ratio of 10.0:1 in 2000 at the apex of the dot-com delirium. The increase in this ratio largely stems from significantly higher acquisition prices, coupled with only modest increases in investment levels prior to acquisition. The largest VC-backed company acquisition of 2014 was Facebook’s acquisition of WhatsApp for a stunning $19 billion. There were a total of 23 VC-backed company acquisitions for

US Market Review and Outlook 5 at least $500 million in 2014, up from nine in 2013. Billion-dollar acquisitions of VC-backed companies increased to nine in 2014, up from seven in 2013. The above comparison of the ratios of valuations to the financing amounts required to achieve liquidity events indicates that for only the second time since 2000—but for the second consecutive year—returns to venture capital investors were higher in M&A transactions than in IPOs in 2014. Furthermore, venture investors generally achieve liquidity more rapidly in an M&A transaction (which frequently yields the bulk of the purchase price in cash at closing) than in an IPO (which generally involves a post-IPO lockup period of 180 days and market uncertainty on the timing and prices of subsequent sales). When combined with the shorter timeline from initial funding to liquidity in 2014 for M&A transactions (5.1 years) than IPOs (6.9 years), these data points underscore why venture capitalists often prefer a company sale to an IPO. The ratio of M&A transactions to IPOs for venture-backed companies declined for the third consecutive year, reaching 4.7:1 in 2014 compared to 6:2.1 in 2013. The 2014 ratio was the lowest annual ratio since the 2.4:1 in 2000.

OUTLOOK The overall performance of the venture capital market in the coming year will depend on a number of factors, including general economic and capital markets conditions and the amount of fundraising by venture capital funds. Subject to these uncertainties, we offer the following insights: ■



Financing Activity: Venture capital financing activity should continue to be brisk in 2015. Valuations, however, seem ripe for some contraction in light of the lofty levels achieved in 2014. Early results in 2015 show a modest decline in deal flow compared to 2014, although a number of recent large financings demonstrate the market’s continued capacity for outsized rounds when warranted. IPOs: On the heels of a very good IPO market for venture-backed companies

Acquisitions of US Venture-Backed Companies and Median Time to M&A – 1996 to 2014 # of deals

Median time from initial equity funding to M&A (in years)

529 489

464

399 348

4.0 284

1996

2.8

1997

1998

5.8 427

4.6

5.5

552 5.3

5.3

473

5.2 449

409

483 5.1

5.0

3.7

3.5

232

199

563

6.5 6.0 519

5.4

435

4.7

533

508

2.8

2.4

1999

2000

2.1

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: Dow Jones VentureSource

Median Amount Raised Prior to Acquisition and Median Acquisition Price – 1996 to 2014 Median amount raised prior to acquisition Median acquisition price $ millions 100

75 60

58

55

50

46 40 33

5.5

5.5

1996

1997

31

6.9

1998

11.3

10.0

1999

2000

15.0

2001

20 19.5 17.0 19 18.4

2002

2003

38

35

30

27

19.2

2004

50

32 20.1

20.0

2005

2006

2007

19.9

2008

19.8

25

2009

19.0

2010

15.5

2011

16.9

2012

11.3

2013

14.5

2014

Source: Dow Jones VentureSource

over the past five years, including an exceptionally strong year in 2014, expectations remain high for the IPO market in 2015. However, a number of attractive IPO candidates—including a growing number of “unicorns” valued in excess of $1 billion—appear to be biding their time before going public. The VC-backed company IPO market has begun 2015 at a more measured pace than in 2014, but various VC-backed companies are positioned to pursue large IPOs later this year if they so choose. ■

Acquisitions: Prospects for the M&A market for venture-backed companies appear promising. Strategic acquirers have excess cash to deploy, and the existence of a credible IPO alternative enhances the leverage of venture-backed companies in

negotiating acquisition prices. The start of 2015 has already seen several large acquisitions of VC-backed companies. ■

Attractive Sectors: Technology companies leveraging the massive adoption of smartphones and mobile applications and the ever-increasing level of broadband connectivity, as well as companies deploying SaaS models or focused on major business challenges such as cybersecurity, should continue to be prime targets for VC funding. Healthcare IT and life sciences companies with compelling market opportunities should also continue to attract funding, particularly as the high level of life sciences IPOs in 2014 produces investment returns that should help venture capital fundraising.