In the past few weeks, we have been hearing about a number of significant deals, especially in the world of startups. AirBnB just raised an epic $850mn with a valuation of $30bn. Uber sold its China arm to Didi Chuxing in a deal that valued the combined entity at $35bn. Few weeks ago, Unilever bought Dollar Shaving Club for $1bn. Most recently, Walmart acquired Jet.com for $3bn. To a casual observer, these deals may not seem to have anything in common. However, a closer look reveals a few common threads that underlie all of them.
Plenty of Money to Go Around
The most obvious common denominator is that AirBnB, Uber China, Dollar Shaving Club and Jet.com are all results of abundant supply of capital. As we discussed in Global State of Stock Markets, low interest rates have induced more capital to move into the equities (including public stocks and venture capitals) than ever before. Because capital has been relatively easy to get for the past few years, these companies have been able to raise hundreds of millions of dollars (if not billions) without much trouble.
|AirBnB||Uber China||Jet.Com||Dollar Shaving Club|
|Total $ Raised ($ mn)||$2,390||+$2,000||$565||$90.7|
Until recently, raising money had been quite easy, especially if you were a market leader or if you were a well-known startup. In some cases, you didn’t need a viable business plan to raise capital if you well well-known. For instance, even big companies like Uber China or Jet.com lacked a credible business strategy when they raised capital; they mostly leveraged their celebrity status to attract investors. Uber China had been engaged in a hopeless arms race against its local rival Didi Chuxing in a country notorious for being a graveyard for foreign tech companies. Jet.com won over investors with a famous founder who had a personal vendetta against Amazon and vowed to bring down the retail giant, only to change its business models multiple times while burning cash and failing to get much traction in the market.
Rationalization of Market or Symptom of Weakness?
What has been happening recently is quite interesting. Pitchbook has put together a data set of VC deals in US. The table below shows that while dollar raised continues to rise (+11% Y/Y in 2Q 2016), number of deals have been falling (-30% Y/Y in 2Q 2016), almost tripling the average deal size from $4.5 million in Q1 2013 to $11.7mn in Q2 2016. What this implies is that investors are flocking to big, well-known companies, while reducing investments in smaller firms. Big organizations are getting more money than before, and smaller startups are having more difficulty raising capital.
|Deal value ($Bn)||# of deals closed||$ raised per deal ($mn)|
Such behavior may imply that investors have begun to rationalize or curb their optimism, and have begun to concentrate on most promising companies while avoiding riskier bets. As a result, clear market leaders (at least so far) like AirBnB and Snapchat continue to have easy access to money, while companies with less clear future or insufficient scale like Uber China, Jet.com and Dollar Shaving Club are being forced to find alternatives by selling themselves. They are two sides of the same coin. Meanwhile, public companies like Unilever and Walmart are more than happy to provide exits to the desperate startups. After all, financing is cheap and capital is abundantly available. What better way to fix one's problem is there other than throwing money at it?
There is a negative connotation to this phenomenon as well. For the past few years, low interest rates have released abundant (if not excessive) amount of capital, and markets have been booming (S&P 500, M&A deal flows, and VC investments all have reached peak in the last 12 months). Investors have been sitting on a lot of capital and have been enjoying great returns without much effort. However, there have been more than a few market scares recently, and there definitely are reasons to be concerned, as we discussed in State of Global Stock Markets. Given this, it may just be that investors are taking refuge in “high quality” market leaders like AirBnB and Didi Chuxing, leaving others without fuel to continue their fight. While it is good to see some moderation in investor optimism, it is discouraging to observe such a herding behavior at the top of the market. Such behavior could be a sign of weakness in the financial market and of more bad things to come. Not only that, this situation in the start-up world is weirdly reminiscent of socio-political issues in the real world today: money begets money, and the rich keeps getting richer.
*Views expressed here represent those of the author’s alone. This article is not a recommendation to take any type of action in the financial market.