Venture capital funds are hot right now. In the first half of 2017, £1.1bn was invested into London start-ups alone, with the majority of the money being invested into the tech industry. Indeed, London’s tech startup growth, largely backed by VC funds, has defied the odds to continue staggering levels of development since what many perceive to be is birth point in 2008, in the aftermath of the financial crisis.
To say that this growth has defied expectations is an understatement. Even now, it is hard to find commentary on the startup tech industry without the phrase “bubble” appearing. However, whilst many predicted that the Silicon Roundabout (named after the location of many start-ups on London’s Old Street roundabout) would fall in 2016, where it was common to see a company being valued at 15-20x their EBITDA (Earnings Before Interest, Tax, Depreciation, Amortization), the industry still remains strong. There are even predictions that the valuations of these fast-growth companies could exceed their current EBITDA multiples before the year is out.
With fast-moving growth, the threat of collapse is always a possibility. However, in this instance, the collapse might not necessarily result from a lack of money flowing into the industry to keep it afloat, but rather too much of it.
Just as a lack of investment in an industry can prove to be disastrous, so too can overinvestment – especially when the investment arises from independent parties expecting returns. In 2016, £5.7bn was raised by VC funds in Europe, with London based funds playing a significant part in increasing this figure. Indeed, even in recent months, firms (such as Felix Capital) are raising in excess of £100m, showing that there is far from a shortage of funding reaching the industry. Where a shortage could exist, however, is in the number of companies to invest in.
The Search for Unicorns
These monumental fundraising achievements are no doubt backed on funds’ recent abilities to command huge returns for their investors. However, investors must be wary for how long such returns can be delivered. As more and more money is pumped into the industry, an increasing number of funds search for the next “unicorn” to invest in, and with more funds on the hunt, the search becomes more frantic. The question that arises then is how many unicorns exist, and is the amount of money being pushed into the industry justified by the value of start-ups?
For a long time, the continual rising value of start-ups balanced out the influx of industry fundraising. However, whilst value and fundraising both continue to grow, it appears that fundraising is now growing at a faster rate. Whilst the issue of “too much investment” may not seem to be too much of a problem, it could, in reality, prove to be disastrous for the industry. Unless the industry is able to provide a constant supply of investment worthy companies, VC funds will be faced with some particularly tricky decisions to make.
Options to Open Funds
Realistically, there are two options open to a fund without investment ideas – either they will hold their investors’ money as dry powder (un-invested capital held in a fund’s account), or, under pressure from investors to make returns, they will invest in companies which otherwise would not be seen as investment worthy. Both of these instances represent losses for investors and, should they become an industry-wide trend, the appeal of VC fundraising would lessen. The overfunding of the tech industry could feasibly result in a funding shortage as, without constant returns, investors would seek other areas to place their money.
Fortunately, there are some redeemable aspects of the industry. Its tech-driven nature leads it to be innovation focused, meaning that new companies are constantly developing. Fund managers will have the tricky job, however, of deciphering which companies are propagating lasting technology and which companies are doomed to fail. As the industry grows this decision becomes harder, and as the fundraising grows, the onus on making the right investment decisions becomes critical.
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