*UPDATE: VC Investing Slowed Slightly in Q2. But a Local Expert Said It’s Still on Pace to Top a Record 2018…
By Jeffrey Grabow, EY US Venture Capital Leader
With the second quarter of 2019 at a close, the pace of venture capital investing slowed slightly and seemed to settle after a large decline in Q1, following a record Q4 2018. Despite a successive decrease from the previous quarter, I’m not ringing alarm bells. In fact, quite the opposite. We are already outpacing the record year we had in 2018, and the market is primed to ensure VC activity remains strong. However, there could be a canary in the coal mine — VC investment in China was down more than 75% this past quarter. It will be interesting to see if this has any correlation in the coming quarters for the US VC market or if it remains contained to the local Chinese market.
Nationally, venture-backed startups raised $29.3 billion in Q2, a 2% decrease from Q1. Perhaps most notably, we saw a 74% dip in investment dollars from the private equity sector — $1.2 billion in Q2 vs. $4.7 billion in Q1. We did see more mega-round investments take place, representing an increase of 19% over the previous quarter. The $12.7 billion raised from these deals accounted for 44% of all capital invested in Q2, only a slight decline from 50% in Q1.Despite the relative stability of the venture asset class, it’s important that we evaluate the factors contributing to changes quarter over quarter. Nationally, venture-backed start-ups raised $29.3 billion in Q2, a 2% decrease from Q1. Perhaps most notably, we saw a 74% dip in investment dollars from the private equity sector — $1.2 billion in Q2 vs. $4.7 billion in Q1.
Looking beyond Q1’s shifts, some trends were consistent quarter over quarter. As in Q1, 75% of all capital raised in Q2 was generated by three top sectors: information technology (28%), business and financial services (25%), and health care (22%). Between the ongoing rise of software, the burgeoning strength of FinTech, and the rapid technological shifts reshaping patient care and the biopharmaceutical industry, these dominant sectors are at the heart of the innovation economy. And investors are taking notice.
So where is the bulk of VC activity taking place? As in Q1, the top markets come as no surprise. With $13.7 billion raised in Q2, the San Francisco Bay Area accounts for 47% of all capital in the US. Being on the ground, I can tell you that the environment here remains incredibly vibrant and fast-paced. New York and Boston hold the second and third spots, accounting for 13% and 8% of US capital raised, respectively. New York is a startup hot spot in its own right, and Boston’s elite universities attract and incubate young talent. However, New York and Boston both saw decreases this past quarter of 35% and 10%, respectively, in terms of dollars invested.
In my role as EY US Venture Capital Leader, there is nothing I love more than drilling down into the numbers to understand how the VC landscape is changing. However, it’s equally important to step back and look at the results with a wider lens. As we enter Q3, here are the forces I believe will help the VC market maintain its momentum going forward:
- Unicorns and others are going public. There is a growing list of companies seeking the public markets. Each successful offering will push others to consider going public.
- There are more themes and sectors to back than ever before. Between aerospace, FinTech, blockchain, autonomous driving and agritech, innovation is creating a gamut of new and dynamic investment areas. Corporations feel a strong need to keep up with the rapid pace of change on the horizon, which bodes well for investment opportunities.
- The economy is primed to encourage continued investment. Interest rate hikes appear to be on hold with a potential cut in 2019, which could unlock more capital for the venture asset class. And with an impending economic slowdown somewhere on the horizon, investors are also likely to encourage their portfolio companies to get as fully capitalized as possible.
- The rollout of 5G could spark massive spending by telecommunications providers. This could drive investment in the area by providing opportunities for startups with elegant, cost-efficient software and hardware solutions. That being said, the increasing involvement of government in technology could lead to potential regulation or oversight impacting the M&A activity of venture-backed companies. It also could mean more companies go public.
VC investment activity is positioned for success in the near term, but let’s make no mistake — healthy business markets ebb and flow, and this sector is not protected from cyclical changes. Eventually, capital will tighten, leading to fewer dollars and deals on the table. We’ve seen this playbook before, so I’m less interested in what will transpire after the slowdown hits, but rather what forces will precipitate it in the first place. But until that slowdown begins, the pendulum swinging between investors and founders remains on the founder-friendly side.
While the pace of venture capital investing slowed slightly during the second quarter of 2019 after a record Q4 2018, this should by no means raise alarm bells. VC investing is already outpacing 2018, and the market is primed for strong near-term VC activity.