Investors are Pricing Rounds Up, but Fearing the Bubble [Contributed by Mike MacKeen, originally published on Raising the Next Round | Bulger Partners]Analytics are out on the private financing market during Q3. We should all appreciate that Wilson Sonsini and Cooley each make the effort to aggregate and publish term sheet analytics. The law firms can only report on transactions where they advise, but the collective data are by far the most detailed view into trends in term sheet structure.The big takeaway for CEOs thinking of funding is that capital remains available – 80+% of all financing rounds were up rounds in Q3. WSGR reports it is the highest level of up rounds since they began tracking data. The WSGR graph below shows the recent quarterly trend:It is unlikely that 80+% of portfolio companies are making their budget numbers. Therefore, the wealth of up rounds suggests investors are giving companies the benefit of the doubt and placing credence in future growth plans.The other conclusion is that “bubble” fears are impacting investor behavior unevenly across the private tech landscape . Median valuations declined across early and mid-stage financings, a trend that started mid-year. However, the unicorn-hunting mentality, which ignited bubble fears by creating a class of multi-billion dollar private companies, has not abated. Series D+ financing was the only class to see a Q3 valuation spike in in Cooley’s analysis.Total capital commitment in Q3 declined relative to the past two quarters. However, the comparable periods are two very robust quarters. Financing commitments in the growth end of the market are already past the total for all of 2013. CEOs can be comfortable that capital supply is adequate. LPs are commiting to the asset class in both venture and buyout as recent funds at Cannan Partners and Vista Equity attest.The interesting details in the law firm reports are the trends in specific financing terms. What appears clear is that terms seem to be coming into uniformity. That may be due to increased use of standard NVCA documents. It could also be due to group think on “market” terms among Partners in one law firm. Regardless of source, the result for the market is positive. It is easier to negotiate a transparent price and much easier to structure follow-on financings when terms narrow.We can see from the analysis that a standard term sheet looks like this:
- No participation rights
- A dividend, but a non-cumulative one
- Broad-based weighted average anti-dilution protection
- No pay-to-play provisions
Redemption seems to follow a geographic pattern as firms outside California use it more often. I find redemption to be situation specific. If investors in the aggregate own more than 50% of the voting shares, as often happens in a venture-backed business across multiple rounds, redemption is redundant. Investors who leave a Founder in voting control should likely have a redemption provision. So it is not surprising to see redemption in single-investor, minority growth investments, a strategy deployed more broadly outside CA.One data point disclosed in the reports that might be confusing is the frequency of a senior liquidation preference. The WSGR survey suggests the new financing has senior preference in about 35% of the investments. This may be deceiving as there is no information about the investing syndicate. If the B or C round is 100% funded by existing investors, as does happen, a pari passu liquidation is typical. When we see new investors entering the syndicate in the follow-on round, our experience is the latest round has a senior preference.The takeaway for the CFO and CEO is if you are thinking about a capital raise, the market is open and the transaction terms are getting a little bit easier to understand.