Early stage VC funds play catchup with later stage peers
Early stage VC firms are playing catchup and have the potential to generate higher returns than their later stage peers, according to new research.
British Business Bank (BBB) research shows early stage funds have generated a pooled Distributions to Paid In (DPI) multiple – the amount paid to investors – of 1.43, 0.73 per cent higher than later stage VCs.
Additionally their pooled Total to Value Paid In (TVPI) multiple – the investment multiple – is 0.71 per cent higher than later stage peers at 1.99.
Early stage funds are those that focus specifically on earlier rounds such as seed and Series A rounds, and tend to have smaller deal sizes.
The BBB said they pursue a “high risk, high reward strategy” which means they have more potential to generate large investment multipliers because valuations can grow exponentially. For example Scottish Equity Partners is reported to have made a near 50 times return on its £9m deal in Skyscanner.
By contrast later stage firms may invest in firms with a proven model but require larger deal sizes and less extreme growth.
The early stage market has grown rapidly over the last decade but research shows activity is beginning to soften in 2019 and 2020.
The BBB 2020 Equity Tracker report showed the annual amount of investment going to seed stage companies declined for the first time in 2019, ending continuous year-on-year growth since 2011.
This is even before the impact of the pandemic which will likely disproportionately hit early stage financing.
“The health of the early stage equity ecosystem is important for the overall ecosystem as it provides the pipeline of companies for later stage investors to invest in,” the BBB said.
Despite the hit to deal flow, a BBB survey of fund managers as part of its report found that fund managers are still optimistic albeit with mixed views on exit and fundraising conditions.
Positively as of the end of September 2020, most fund managers felt that the quality of investment opportunities had not worsened but was the same as those a year ago.
Alice Hu Wagner, managing director for Strategy, Economics and Business Development at the BBB said: :It’s important for investors to know that early stage venture capital funds have the potential to generate high returns, as the early stages of the market are important for the health of the overall equity ecosystem, including later stages.”