Bubble? What Bubble? How It's Different This Time. And How It Most Certainly Isn't

Venture Capital 2016 - Some Upfront Views Mark Suster 1 @msuster

There is Some Stuff We All Know We all know the funding markets for venture-backed startups have been strong for 7 straight years 2

LP contributions to the VC industry are back to pre-recession levels and anecdotally 2016 seems likely to increase further US VC fundraising activity $60 Capital raised ($B) 300 # of funds closed 271271 $45 233233 236236 235235 235235 225 214214 218218 209209 192192 $30 162162 176176 150 $30 $31 $30 $31 $28 $25 $15 $19 $20 $18 75 $16 $13 $0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 Source: Dow Jones VentureSource; Upfront analysis.

With more money (and new non VC entrants) venture financings have obviously increased. 2015 was an enormous year (2x pre recession) US VC financing activity $100 Capital invested ($B) 9,3819,381 10,000 # of rounds closed 8,5638,563 8,0978,097 7,5727,572 $75 6,4286,428 $77 7,500 $68 5,1935,193 $50 4,1194,119 4,5334,533 4,3164,316 5,000 3,1453,145 $42 $40 $44 2,5742,574 $35 $36 $25 $28 $26 $30 2,500 $23 $0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 4 Source: PitchBook 2015 Annual U.S. Venture Industry Report; Upfront analysis.

And what's interesting is that if you look at the spread between dollars raised by VCs and dollars invested, you see the huge shift from a decade ago of non-VC capital US VC fundraising vs financing (2006-07, $B) US VC fundraising vs financing (2014-15, $B) 175 175 2.5x 145 140 140 105 1x 105 70 61 63 70 59 35 35 0 0 Funds raised by VCs Funds invested by VCs Funds raised by VCs Funds invested by VCs 5 Source: Upfront analysis.

Angel & Seed deals have grown fastest but dollars have scaled massively into a smaller number of later-stage deals (doubling in just 2 years) US VC # of rounds closed by stage US VC capital invested ($B) by stage 5,000 CAGR 50 CAGR Late 36% Angel/ Stage 4,000 Seed 22% 40 3,000 30 Early 3% Early 16% Stage Stage 2,000 20 Late 1% 1,000 Stage 10 Angel/ 21% Seed 0 0 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 6 Source: PitchBook 2015 Annual U.S. Venture Industry Report; Upfront analysis.

And the dollars into late-stage deals has largely been driven by non- traditional VCs entering the market (up 50% in the last 3 years) Non-VC participation in US $20 million-plus rounds 60% 45% CAGR ’12-’15 30% 55% 15% 47% 47% 37% 15% 0% 2012 2013 2014 2015 7 Source: CBInsights, VC-backed $20M+ rounds; non-VC defined as Asset Mgmt, Corporate/Corporate VC, Family Office, Hedge & Mutual Funds; Upfront analysis.

M&A pace hasn’t matched the increases in funding pace so VC mark-ups have been good but cash distributions less so US VC-backed M&A activity $150 Amount Paid ($B) 600 Number of M&As 542542 $113 510510 525 462462 470470 473473 $75 $81 450 $47 $54 $38 $43 $42 375 $0 300 2011 2012 2013 2014 2015 8 Source: Dow Jones VentureSource Venture Capital Report 4Q’15; Upfront analysis.

IPO exits are down 32% in volume and 38% in value US VC-backed IPO activity $15 Raised ($B) through IPO 120 Number of IPOs 107107 $11 $11 90 7373 $9 6666 $8 50 $8 60 4646 5050 $6 $5 $4 30 $0 0 2011 2012 2013 2014 2015 9 Source: Dow Jones VentureSource Venture Capital Report 4Q’15; Upfront analysis.

But there are other truths that people have only recently begun to speak about 10

Public Tech Markets are obviously off dramatically in the past three months beginning the question of what this means for private valuations NASDAQ (9%) LinkedIn (18%) Apple (19%) Twitter (41%) 11 Source: 3-month valuations November 02, 2015 to January 29, 2016; Upfront analysis.

Private market valuations had risen beyond what some believe are sustainable (up 3x in 2 years). Q4 saw massive correction (we asked VCs if they thought it was an anomaly or a trend). US VC-backed financing median pre-money valuation ($M) $80 $68 $60 $60 $58 $51 $53 $40 $37 $24 $28 $20 $21 $22 $17 $19 $0 1Q'13 2Q'13 3Q'13 4Q'13 1Q'14 2Q'14 3Q'14 4Q'14 1Q'15 2Q'15 3Q'15 4Q'15 12 Source: Dow Jones VentureSource Venture Capital Report 4Q’15; Upfront analysis.

More than 90% of respondents in the Upfront VC Survey expected valuations to go down in 2016 with a full 1/3rd of investors expecting significant price corrections Do you expect valuations to go up, down or remain about the same as previous quarters? 100% 5% 30% 61% 75% 61% 50% 28% Significantly down 25% Marginally down About the same 0% 6% 8% Increase Q4'15 1H'16 Proj 13 Source: Upfront Survey Jan 2016, 156 VCs for Q4’15, 158 VCs for 1H’16; Upfront analysis.

This is coupled with a very visible recalibration of valuations of the pre-IPO mutual fund cohort at places like Fidelity Fidelity’s holdings: % valuation change since purchase Blue Bottle -61% MongoDB Series F -54% Taboola.com Series E -47% Turn Inc. -45% Zenefits Series C -44% Dataminr Series D -35% Dropbox Series C -29% Snapchat Series F -15% 0% 25% 50% 75% 100% 0% -25% -50% -75% -100% 14 Source: Fortune; Blue Bottle, Dropbox, Snapchat and Benefits data as 11/30/2015, rest as of 9/30/2015; Upfront analysis.

This has swung sentiment for many experienced VC firms firmly toward controlling burn over rapid growth 15

This was clearly borne out in the Upfront VC Survey where 62% of firms are advising companies to cut costs / burn as markets tighten Which statement best describes the spending behavior at most of the companies in which you are on the board or observe? Generally not too worried about burn rates 4% Don’t see much change from a year ago 35% Generally cutting costs expecting 62% markets to tighten 16 Source: Upfront Survey Jan 2016, 156 VCs.

“Winter is Coming” message received by portfolio companies 17

“Winter is Coming” message received by portfolio companies 18

And with fewer VC exits many partners are more overloaded with boards and financings and feel less pressure to do new deals quickly. FOMO is on the decline. Average number of board / observer seats 10 8 8 6 7 5 4 4 3 2 0 0-3 years 3-6 years 6-10 years 10-15 years 15+ years Years of investment experience 19 Source: Upfront Investor Survey, sample size of 76 early to late stage VCs, excluding angel/seed and corporate VCs; Upfront analysis.

There is a clear feeling that fund raising cycles are taking longer and 77% felt this pace is likely to slow down even further in 2016 Do you expect deals to take longer in the process than previous funding quarters, the same or shorter? 100% 45% 77% 75% 50% 51% 25% 22% Getting longer About the same as normal 0% 4% 1% Shorter than normal Q4'15 1H'16 Proj 20 Source: Upfront Survey Jan 2016, 159 VCs for Q4’15 and 158 VCs for 1H’16.

50% of respondents indicate they may slow down their pace, 35% thought it would be the same pace as 2015 and only 16% expect 2016 to be robust How would you generally describe your investment mindset heading into 2016? “I’d rather fund when the dust settles “Unless a deal is amazing I’m likely to slow my pace a bit” “Seeing tons of great deal flow and expect this to be 1% a solid year” 4% 16% “I don’t feel compelled to do deals” 43% 35% “2016 about the same pace as my last several years” 21 Source: Upfront Survey Jan 2016, 158 VCs.

With the sentiment of the markets it’s no surprise that a full 82% of VCs expressed caution or concern going into 2016 Which of the following statements best describes your mood heading into 2016 Things are bad & getting worse Hugely bullish 2% 9% Generally optimistic I’m very concerned 9% 30% 50% Generally cautious 22 Source: Upfront Survey Jan 2016, 155 VCs.

And how does the growth in funding, valuations and anxiety play in the minds of LPs who fund the VC industry ultimately? 23

The good news is that only 7% of LPs believe they will cut back on venture programs with 26% of funds looking to increase exposure How would you describe your fund’s current allocation to VC? Aggressively growing venture Too much allocated to venture 4% 7% Trying to grow our venture program 22% 67% About the right allocation 24 Source: Upfront Survey Jan 2016, 73 LPs.

But LPs expressed caution, too. Nearly 75% of LPs have concerns about investment pace, valuation levels and burn rates of underlying companies. How would you describe your fund’s outlook on your existing (VC) managers activities? Deeply concerned about the market behavior 6% Very happy with investment activities of 26% our existing managers A bit concerned by pace, valuation 68% creep and burn rates 25 Source: Upfront Survey Jan 2016, 72 LPs.

61% of LPs believe that VCs are coming back to market to raise money at too quick of a pace - a reflection of anxieties of the over-funding of portfolios How would you describe your fund’s outlook in your existing (VC) managers funding (and fund raising) pace? Managers come back at a normal 24% cadence and it hasn’t changed much Managers have been coming back more 61% quickly than in the past and it concerns us 15% Managers have been coming back more quickly than in the past and we’re fine with this 26 Source: Upfront Survey Jan 2016, 72 LPs.

But a full 82% of LPs are likely to maintain their existing investment pace How would you describe your likely investment pace in venture over the next 3 years? We’re likely to slow down our investment pace We’re likely to increase our investment pace 10% 8% 82% We’re likely to keep the same investment pace 27 Source: Upfront Survey Jan 2016, 73 LPs.

While the market for Seed Funds grew enormously in the past 7 years, many LPs still express some concerns about capacity and market crowding What is your fund’s outlook on the seed market? Seed delivers the highest potential returns and we’ll There are too many seed funds and we’re worried they continue to invest heavily won’t have enough capacity 11% 23% We fund seed VCs but we’re very 66% discerning on which ones we’ll fund 28 Source: Upfront Survey Jan 2016, 70 LPs.

Also it’s not too surprising that LPs are most cautious about growth stage funds - in particular concerns about late-stage valuations What is your fund’s outlook on later stage venture capital / growth equity? We like growth stage but want a healthy balance of 32% seed, A/B and growth We’re worried that the growth stage is 68% the most over-valued part of the market 29 Source: Upfront Survey Jan 2016, 71 LPs.

What to make of all of the uncertainty and potential change in the VC markets? 30

Expect loss ratios to go up. But ultimately the creative destruction of these storms can be good. New startup cohorts will sprout where others get cleared out. 31

A slowing pace should be healthy for startups and for VC returns. We believe the next 3 years will value patience over speed at all costs. 32

And despite market concerns in the short-term, as an asset class we see so many industries ripe for innovation and disruption Transportation VR & AR Computational Biology Food & Agriculture Aerial & Space-tech 33

Venture Capital 2016 Thank You. Mark Suster 34 @msuster

159 VCs surveyed Fund type Position 60 60 140 134 47 40 93 20 19 47 7 6 9 1 1 9 7 0 0 Angel Seed VC (Early) VC (Mid) VC (Late) PE Corp (blank) Partner / MD Analyst to Principal Sole proprietor/personal investor Fund size ($ million) How long has your firm existed (years) 60 47 70 61 40 33 28 31 36 19 35 22 20 9 7 7 0 0 $1-20 $20-100 $300-999 $100-300 $1000+ Evergreen Personal 0-3 3-10 10-20 20+ Survey respondent geography Personal investment experience (years) 80 79 80 31 43 41 40 24 40 30 23 8 7 13 0 1 0 Norcal SoCal NE US Other US ROW (blank) 0-3 3-6 6-10 10-15 15+ 35 Source: Upfront Survey Jan 2016.

73 LPs surveyed, part 1 Fund type Fund size 30 28 20 18 23 16 14 20 11 10 7 10 9 5 4 4 3 4 0 0 Foundation or Fund of Family Discretionary Insurance Other $0-250M $250-750M$750M-1.5B $1.5-5B $5-10B $10B+ Blank Endowment Funds Office Advisor Company Which of the following best describes your focus on VC? Survey respondent geography 50 30 28 42 22 25 19 15 11 10 6 4 2 2 0 0 Only VC Mostly VC Very diverse Not much VC NorCal SoCal NE US Other US ROW Blank 36 Source: Upfront Survey Jan 2016.

73 LPs surveyed, part 2 Position How long has your firm been investing in VC (years) 60 54 40 30 40 23 20 16 20 18 1 3 1 0 0 Partner / MD Analyst to Principal Blank 0-3 3-10 10-20 20+ Haven’t invested much in VC How long has your firm existed (years) Personal investment experience (years) 40 38 40 27 23 20 14 16 20 15 5 4 4 0 0 0-3 3-10 10-20 20+ 0-3 3-6 6-10 10-15 15+ 37 Source: Upfront Survey Jan 2016.