Venture Beacon
Foreword
My recent conversations with venture capital insiders have been imbued with this mixed market sentiment. There’s a cautious optimism about the opportunities ahead, but also an awareness of the ongoing challenges.
The Fed’s recent rate cut brings the prospect of a “soft landing” for the U.S. economy closer into view. The move buoys anticipation of market stabilization and the release of dry powder and new strategies. With lower costs of borrowing at hand, many fund managers and general partners are exploring the use of credit to better manage liquidity and boost returns.
At the same time, pockets of uncertainty are keeping limited partners (LPs) relatively selective with their investments. Many funds are facing difficulties in securing recommitments from LPs, slowing down fundraising efforts.
This report explores the market at this unique juncture. It goes beyond the big-picture trends to drill down into how equity financings are being structured and what deal terms reveal about the dynamics among venture funds, LPs, and founders. As the path to recovery is likely to be inconsistent and uneven, detailed data like this is key to distinguishing between temporary upticks and sustained recovery, and identifying where risks and opportunities lie.
At J.P. Morgan Private Bank, we’re committed to helping our clients turn data into actionable insights. Our partnership with Aumni is part of this commitment, enhancing our ability to provide clients with information to make well-informed decisions, even in uncertain times.
Head of the Fund Banking Group
J.P. Morgan Private Bank
Executive Summary
- Pre-money valuations improved in the first half of the year, as did late-stage lead investor check sizes. Improvements in the data appear to be driven by the top end of the market.
- The median time between financing rounds meaningfully declined for the first time since 2022, from 25 months to 22 months, but still remains historically elevated.
- Down rounds considerably increased for late-stage companies. Median markdowns remained at similar levels in the first half of the year for all stages except Series B, which increased to approximately $79 million from $34 million in 2023.
- Follow-on investments are increasing in prevalence, and appear to be at the highest levels in the previous 10 years.
- Secondary transactions executed at a premium to the price per share of the most recent priced equity round increased in prevalence to 36%, from 32% the year prior. The average value of a secondary tranche is steadily increasing as well, while the relative price per share of common vs. preferred equity classes is decreasing.
- The trend toward convertible notes is reversing, as Simple Agreements for Future Equity (SAFEs) become more common before and after priced equity rounds in the first half of the year. Convertible notes before priced equity rounds decreased in prevalence to a six-quarter low in Q2 2024.
- Convertible note interest rates are holding steady, while discount rates greater than 20% are increasing in prevalence.
Overview
At a high level, the venture capital market improved in the first half of 2024, driven by increased pre-money valuations in Q2. Median pre-money valuations increased between 6% and 32% in early-stage deals (Seed through Series B) and by over 150% for Series D+ compared with the previous year.
Coinciding with the rise in pre-money valuations, median late-stage lead investor check sizes similarly increased in the first half of the year to just over US$30 million, a level not seen since early 2022. Meanwhile, the percentage of a round taken by the lead investor has remained stable, with mild fluctuations from quarter to quarter but without any clear trend up or down.
With the exception of Series D+, total cash raised in the first half of 2024 has largely remained unchanged across stages. Taken together, the data suggests that the increased momentum in the venture capital market does appear to be driven by pre-money valuations, particularly at later stages, and not necessarily just an increase in new money deployed. With Series D+, the data suggests both an increase in pre-money valuations and a notable increase in the median amount of capital raised in the first half of the year.
And yet, even though the general trend appears to be positive, a deeper look at the interquartile range of post-money valuations reveals that the market shift is occurring at the top quartile of the market. Across financing stages, there is a clear divergent trend between top quartile valuations, which have seen significant momentum in the first half of the year, and the median and bottom quartiles, which remain relatively flat and unchanged. The headline data that valuations improved, therefore, does not paint the full picture, as the recovery in the first half of the year seems to be mostly driven by the top end of the market.
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Equity Financing Benchmarks
Down Rounds and Dilution
The trend of increasing down-round prevalence since 2021 appears to have reversed in the first half of 2024 for early-stage companies. Down rounds for early-stage startups decreased to 15.6% in the first half of the year from 21.5% in the previous half-year, while up rounds increased to 74.9% from 66%. Flat rounds for early-stage companies declined to 9.51% from 12.5% in the second half of 2023.
The opposite is true for late-stage companies, which saw down-round prevalence in the first half of the year increase by a considerable margin. Down-rounds for late-stage startups increased from 28% in the second half of 2023 to approximately 39% in the first half of 2024. Nearly half of late-stage rounds in the first half of 2024 were either flat or down.
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Median markdowns remained at similar levels in the first half of the year, moderately increasing for all stages except Series B, which increased more substantially to nearly $80 million in 2024 from $34 million in 2023.
The increasing prevalence of down rounds at later stages and the general increase in markdowns speak to the divergence between the top and bottom ends of the venture market.
Dilution, meanwhile, has continued a mild downward trajectory for both early-and late-stage financings to 5-year lows in the first half of 2024. Median late-stage dilution decreased to 8% in Q2 2024, while median early-stage dilution had a mild uptick to approximately 19% during the same period.
Time Between Rounds and Follow-On Investments
In welcome news, the average and median number of months it took companies to raise capital meaningfully declined in Q2 2024, implying that startups experienced a relative improvement in the ease of raising capital. The median time between rounds across all stages decreased from 25 months to 22 months in Q2 2024, but remains historically elevated and nearly 30% higher than 2020 levels.
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Coincidentally, follow-on investments are becoming more common. In 2023, follow-on investments increased to approximately 29% of all deals in Aumni’s database, and have remained at similar levels so far in 2024. The proportion of capital raised from follow-on investments increased to 23.3% in the first half of the year, from 21.9% in the second half of 2023.
How one should interpret this trend is disputable, as it is not clear from the data if the upward movement is driven by a bullish sentiment from investors toward their portfolio of known startups and founding teams, or instead driven by a bearish move away from new investments in newly established companies by unfamiliar teams. Either way, the proportion of follow-on investments relative to net new investments is at the highest levels in at least 10 years.
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Secondaries at a Premium
Aumni’s data shows an improving environment for secondary transactions in 2024, but still significantly below the levels seen in 2021. Secondary transaction volume in the first half of the year grew to approximately 175% of transaction volume in Q1 2020.
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As the volume of secondary transactions decreased to lows between 2022 and 2023, the number of transactions executed at a discount relative to the price per share of the most recent priced equity round increased from 14.8% in the second half of 2021 to 56.6% in the first half of 2023. The trend reversed in the second half of 2023, and the frequency of secondary purchases at a premium to the price per share of the most recent priced equity financing round increased from 31.9% to 36.3% in the first half of 2024.
The fluctuations in transactions executed at a premium, on par, or at a discount to the most recent priced equity round appear to be roughly correlated to the fluctuations in the average size of an executed secondary tranche. On average, a secondary tranche in Aumni’s data has fluctuated between $2 million and $4 million between 2020 and the first half the 2024, clearly following the overall trend of pre-money valuations in the market.
Curiously, the average relative price per share between preferred and common equity classes sold in secondary transactions does not necessarily follow the same trend. Generally speaking, it is reasonable to expect common shares to trade at a discount to preferred equity classes in the same company, given the increased economic rights that preferred shares usually hold. Common shares in secondary transactions have traded by as low as a 13% average discount relative to preferred shares in early 2024. Notably, common shares traded on average at a 1-to-1 ratio in early 2020 and in late 2022.
Since the start of 2023, the price of common relative to preferred shares on secondary markets has trended down even while average tranche values have been steadily increasing. The branching in the data may reflect that the implied value of the seniority enjoyed by preferred shares is worth more as valuations have come down. Put differently, as the likelihood that companies are not able to get back to previous valuations increases, the more likely common share holders are to get wiped out in a liquidity event, and therefore the more valuable the preferred shares are relative to common.
Convertible Note and SAFE Benchmarks
The recent trend toward convertible notes appears to have reversed in 2024, as SAFEs became more common before and after priced equity rounds in the first half of the year. Convertible notes before priced equity rounds decreased in prevalence to a 6 quarter low of 10.6% in Q2 2024, while convertible notes after a known priced equity round decreased to 72.5% in the second quarter of 2023, from 80.5% in Q1.
Average convertible note interest rates are still hovering at just under 8%, which is not surprising given that, until last week, the federal funds rate had remained unchanged since 2023. Discount rates greater than 20% have been increasing in prevalence in 2024, however, suggesting some change in investor expectations around future interest rates even before the Fed's September rate cut.
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In August 2024, the J.P. Morgan Global Research team released an update noting an increased probability of a U.S. and global recession starting before the end of 2024, and further implying increasing probability that the Federal Reserve will adjust its policy stance and cut rates this year.
With the 50 basis point rate cut from last week’s Federal Open Market Committee (FOMC) meeting, the immediate effects on the venture capital market may well be an adjustment to interest rates and discounts on convertible notes, as further ripple effects across the wider venture capital market may take longer to propagate, given fundraising timelines.
Final Remarks
Overall, data from the first half of 2024 continues to present a mixed picture. On one hand, pre-money valuations markedly improved, late-stage check sizes increased, and the average time between financing rounds decreased. On the other hand, late-stage down rounds increased by a considerable margin, as did median down round markdowns.
The general improvement in the venture capital market in the first half of the year appears to be driven by the top end of the market, and companies caught in the middle are still experiencing considerable pain. The nuanced dynamics of secondary transactions further reveal a divergence in the value between common and preferred equity classes, likely driven by exit scenarios, and a return to paying premiums on secondary markets relative to the price per share of the most recent priced equity financing round.
With the stage set for potentially changing dynamics given last week’s FOMC decision, it will be interesting to see how the venture capital market continues to unfold in the second half of 2024.
Methodology
Data Sources
Aumni obtains primary data from third parties, including law firms, angel investors, VC firms, CVC firms, institutional investors, and others. All data contained in this report pertains to companies with jurisdiction in the United States and is aggregated from an anonymized database of source data. All data is de-identified prior to analysis by our research team.
Definitions
- Amount Raised - The total sum of new money raised in an equity financing round.
- Convertible After a Known Priced Round - Issuance of a convertible note or SAFE after a known equity financing event.
- Convertible Before a Known Priced Round - Issuance of a convertible note or SAFE before a known equity financing event.
- Convertible Conversion - The conversion of a Convertible Security into equity.
- Convertible Note - A short–term debt instrument that converts into equity.
- Convertible Note Interest Rate - The interest rate at which a convertible note’s principal will accrue interest over time.
- Convertible Note/SAFE Purchase Amount -The dollar value of an investment in a Convertible Note or SAFE.
- Dilution - The percentage decrease in ownership of a company due to the issuance of new shares.
- Discount - The discount a Convertible Note or SAFE holder receives on the share price relative to subsequent investors during the conversion of the security in an equity financing round.
- Down Round - A financing event in which a company obtains a new pre- money valuation equal to or less than 95% of the post-money valuation of the previous financing round.
- Down Round Markdown - The difference between a company’s new pre- money valuation and the post-money valuation of the immediately preceding equity financing round in the case of a down round.
- Early Stage - Early stage comprises Series Seed, Series A, and Series B transactions.
- Effective Federal Funds Rate - The effective interest rate at which depository institutions trade federal funds (balances held at Federal Reserve Banks) with one another overnight.
- Flat Round - A financing event in which a company obtains a new pre-money valuation between 95% and 105% (exclusive) of the post-money valuation of the previous financing round.
- Follow-On Investment - A subsequent investment by an investor who has previously participated in an equity financing round in the same company.
- Fully Diluted Ownership - An investor's ownership as a percentage of the total number of shares outstanding for a company, assuming the exercise of all warrants and the exercise of all options, including those reserved but unissued.
- Late Stage - Late Stage comprises Series C and later transactions.
- Lead Investor - The legal entity identified as the lead investor in an equity financing or the one that purchased the largest number of shares.
- Net-new Investment - An investment by an investor who has not previously participated in any priced equity financing round in a given company.
- Post-Money Valuation Markup - The percentage change in post-money valuation from one stage of financing to the next, e.g., the change in valuation from Seed to Series A.
- Post-Money Valuation - The enterprise value of a portfolio company following the closing of an Equity Financing, calculated as the fully diluted share count of a company multiplied by the highest new money original issue price of any equity class issued in an equity financing.
- Pre-Money Valuation - The determined value of a company, usually via a 409A valuation, prior to the closing of an equity financing round.
- Purchase Amount Group - Categories that group convertible notes and SAFEs according to the amount of capital invested in a given company by a distinct investor.
- Qualified Financing Event - A financing event that meets pre-determined criteria and triggers the conversion of convertible securities into equity ownership of the company.
- Secondary Common vs. Preferred Relative Price Per Share - The price paid for a share of common stock relative to a share of preferred stock for a given company.
- Secondary Premium, Par, Discount - Categories for secondary transactions that indicate whether the price per share paid in the transaction was at a value above (premium), the same as (par), or below (discount) the share price associated with the most recent priced equity round.
- Secondary Tranche - An aggregation of multiple distinct transactions, where a single buyer purchases shares in a company from one or more parties, often a mix of founders, employees, and other investors. A secondary tranche represents a high-level view of a single purchaser’s intent to own shares in a given company.
- Series D+ - All priced equity rounds named Series D or later are grouped into Series D+.
- Simple Agreement for Future Equity (SAFE) - A convertible security that allows investors to buy shares in a future-priced equity round.
- Up Round - A financing event in which a company obtains a new pre-money valuation equal to or greater than 105% of the post-money valuation of the previous financing round.
- Valuation Cap - A price ceiling at which a SAFE or Convertible Note will convert to stock ownership.
Methods and Calculations
- Indexed Percentage Change - For the Percent Change in Secondary Transactions data visualization, the 1Q18 deal volume is set to the value of 100, and all subsequent changes in volume reference this initial value.
- Median Rolling 200-Deal - A median is calculated over a rolling window for every 200 deals. This calculation is performed on both capital raised and post-money valuation data. The final output is a weekly average.
- Series Stages - Series A through D+ stage names are based on the legal name of the round and are inclusive of shadow rounds, e.g., Series A is inclusive of Series A-1.
- Time between Rounds - The length of time, measured in months, between two sequential equity financing events for a given company. The final output is a median or a mean across all companies per quarter.
