3 Shifts That Signify Where Venture Capital Is Headed This Year

Following a peak in 2015, investors are adjusting their priorities.
3 Shifts That Signify Where Venture Capital Is Headed This Year
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While entrepreneurs looking for funding should know that venture capital is hard to come by, the number of deals closed has been on a decline. But it’s all relative to robust activity over the past several years. In spite of the slump, recent trends suggest that some investors might be better equipped to write checks this year.

Throughout 2016, U.S. companies raised $69.1 billion in venture capital across 8,136 deals, according to the quarterly Venture Monitor report released by investment data provider PitchBook and the National Venture Capital Association (NVCA). The number of deals fell 22 percent from 2015, a year when unicorns (companies valued at more than $1 billion) proliferated and total funding reached $79 billion. Only 2,340 startups received their first round of VC funding in 2016 -- the lowest number since 2010.

Related: VC Funding Is a Pipe Dream, as Investors Pour Money Into Fewer Companies

Analysts assert that the recent decline is no cause for concern. “After a couple years of frenzied investments and lofty company valuations, the venture capital ecosystem is moving away from a financing peak and returning to a normal, healthy investment climate,” PitchBook founder and CEO John Gabbert said in a statement accompanying the report.

Here are three factors that have shaped the venture industry and are likely to influence investments in the coming year.

1. Venture capital funds raised a lot of money last year.

As the report states, “Going into 2017, the question remains whether venture investment activity has plateaued, or if it will continue to downshift.”

One development that both accounts for the recent drop in activity and indicates that investors may be more active going forward is the degree to which VCs fundraised in 2016. Across the industry, they raised $41.6 billion across 253 funds -- the highest dollar amount in the past 10 years.

Fundraising is time-consuming, PitchBook Senior Analyst Nizar Tarhuni explains, and venture capitalists likely dedicated time in 2016 to focus on that process rather than allocate their dollars. Going forward, the firms who successfully fundraised will be free to distribute their new funds.

2. Investors are more prepared to invest in frontier tech.

Artificial intelligence, virtual and augmented reality, drones, the internet of things, 3-D printing and fintech have been hot topics for years, and as broad industries have formed around them, investors have taken a closer look. Still, it’s taken time to learn about the new technologies, which means it’s taken investors longer to close deals with companies in these new sectors.

Investors don’t just invest in VR as a blanket category, of course. “It takes time to find your niche,” Tarhuni explains. “VR is an ecosystem and a food chain,” with hardware (headsets such as the HTC Vive and Oculus Rift), software, video stitching, motion detection and more. “For investors, it’s about which one jives with their level of understanding and their expertise.”

Artificial intelligence companies raised $705 million in venture capital in the fourth quarter of 2016 -- a 16 percent increase from Q3, according to the MoneyTree Report from CB Insights and PwC, also released this week.

The number of deals closed in 2016 declined across industries. However, the amount of capital that software companies raised increased, PitchBook and the NVCA found. Investors poured $33 billion into the space, which amounted to 48 percent of total invested capital for the year.

Related: 5 Insights Into Venture Capital Entrepreneurs Need to Know Now

3. Fewer VCs have been able to cash out.

While angel/seed, early-stage and late-stage activity all declined in 2016, so did the number of exits -- the point at which VCs get their returns. The year-end total was 142, 39 of which were IPOs.

Whereas 2016 fundraising and enthusiasm about new investment opportunities might boost earlier stage activity this year, the later stages of the VC life cycle remain backed up.

“A sluggish exit market has kept more capital locked away than ever before, causing some VCs to hit the pause button before making more investments,” the Venture Monitor report explains. Late-stage deal count hit a seven-year low in 2016.

Despite intentions to go public (Snap is one of 20 companies that is already registered), PitchBook and the NVCA forecast that it may be difficult. The amount of capital required prior to an exit continues to inflate, but public markets may not support companies with sky-high valuations.

Plus, policy under the Trump administration remains a major unknown. One prediction is that reform to the corporate tax code could keep mergers and acquisitions as the dominant exit strategy.

Edition: April 2017

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