Two law firms have conducted studies of the second quarter venture financing landscape and come to a similar conclusion: Up rounds are getting more frequent.
That, however, was one of few positive takeaways from the two quarterly reports issued last week by attorneys at law firms
By most measures, the venture funding climate continued to reflect a difficult economic environment.
A majority of transactions in Q2 were down or flat rounds. Venture fund-raising was down. And transaction volumes and valuations for the second quarter, as well as the first half of the year, also continued to be significantly below the same periods last year.
“The bottom line takeaway is that we’re skeptical that we’re going to see really significant improvement until the IPO and M&A markets come back,” says Michael Patrick, co-author of the Fenwick & West report.
While it’s likely that Q1 was a bottom in terms of follow-on valuations, Patrick says that he’s not expecting a quick return to normal, noting “it could be a long trough or a very slow recovery.”
Fenwick & West surveyed 89 companies while Cooley Godward talked to 75 companies that completed financing rounds in the second quarter. The Fenwick & West study, which was limited to companies based in Silicon Valley, found that down rounds accounted for 46% of transactions in Q2, unchanged from Q1.
However, up rounds were more frequent, accounting for 32% of transactions in Q2, up from 25% in Q1, as the portion of flat rounds diminished.
The Cooley Godward report found that up rounds accounted for 25% of all deals in Q2, up from 12% in Q1. Survey authors said they took the improvement as “a positive indicator that valuations may be rebounding from first quarter levels.”
Other findings included:
• Companies receiving venture capital in Q2 showed an average price decrease of 6%, compared to their prior financing round, according to Fenwick. This was a slight decline from Q1 when the average decrease was 3 percent. The past two quarters are the only quarters in which the price change has been negative since Fenwick & West began tracking such data five years ago.
• Median pre-money valuations increased in Q2 from the low points seen in the prior two quarters for all stages of financing with the exception of Series A, according to Cooley Godward. Series A pre-money valuations, which averaged $4.4 million, were up from an average of $3.4 million in Q1, but down from an average of $6 million in Q4.
• Fewer transactions over the past quarter included pay-to-play provisions, in which investors who don’t participate in follow-on rounds see their stakes diluted. However, according to Cooley Godward, “a significant number of deals continue to include more onerous terms.” This includes an increase in use of full-ratchet anti-dilution provisions, used to protect earlier investors from dilutive effects of future, lower-priced share issuances.