NEW YORK -- The venture-capital sector is heading back to Earth. The big question for the new year is how bumpy its landing might be.
A new set of data indicates that key segments in venture capital -- the business of funding startup companies -- will be down sharply for 2015, a sign that the dramatic run-up in startup valuations is peaking and the funding of new ones is tapering off.
"There are a lot of indicators that we've reached the peak of the VC investment cycle," said Daniel Cook, an analyst at New York research firm PitchBook Data Inc.
The number of "first financings," the very first round of professional funding for nascent startups beyond money from family or friends, stood at only 1,983 financing deals as of Dec. 1, compared with 3,368 for all of 2014, according to PitchBook. The total dollar amount for first financings figures to be flat or down: $6.91 billion recorded through Dec. 1 compared with $7.5 billion last year.
Meanwhile, money reaped through so-called exits -- via the sale of startups to another company or through an initial public offering of stock -- is projected to end the year off dramatically: about $64 billion on 860 deals compared with $93.77 billion on 994 deals in 2014, according to a Pitchbook analysis.
The drop in first financing "indicates that the future crop of VC-backed companies will be weaker than we're used to seeing," Cook said. Plus, he said, "Exits are down dramatically, and the public markets are in limbo."
Demand for venture-capital funds, however, continues strong, with investors pouring in nearly $37 billion so far this year, up from $34 billion in 2014, to get a slice of later-stage startups such as Uber and Snapchat.
Still, the slowdown for the youngest companies and waning exits indicate a general cooling, analysts said. Among the causes: the lackluster performance of major public stock markets, which provide a guidepost for valuations and an important market for venture capital firms to sell their holdings and exit their positions. Meanwhile, fundamentals in technology, a key sector among venture-capital firms, are weakening.
John Lonski, chief economist for Moody's Analytics, said revenue for software and services was down 2.4 percent in the third quarter from the year-earlier quarter while even once-booming tech hardware saw sales rise only 3.6 percent. "Those numbers are not exactly barnburners," he said.
Investors are pulling back on riskier investments across the financial spectrum, Lonski said, noting that borrowers in the high-yield corporate bond market, often seen as a proxy for venture capital and other risky markets, have been forced to pay ever-higher interest rates in recent months.
Meanwhile, the IPO market in general has hit the skids. The value of deals in the economy was just $36 billion through Dec. 10, compared with $95 billion for all of 2014, according to the research firm Dealogic.
Other cautionary signals for the venture capital sector, analysts say, are recent IPOs that saw highly touted startups trade at lower-than-expected valuations. San Francisco-based payments company Square Inc., for instance, was priced at $9 a share at its November launch, lower than the expected range of up to $13.
Steven Kaplan, a finance professor at the University of Chicago, said 2014 and 2015 marked a "frothy" period of startup valuations that was bound to taper off. He said the rapid rise in the number of startups valued at $1 billion or more, known as unicorns, is coming to an end for the time being.
"A little bit of the luster has come off a lot of the unicorns," Kaplan said. "A lot of them have had trouble maintaining their values."
Some observers see a softening in the venture-capital sector as posing risks to future innovation.
"It's certainly on the decline, and it's a not-so virtuous cycle," Mark Cuban, the owner of the Dallas Mavericks who made his fortune in the dot-com era with broadcast.com, said in an email interview. "Fewer exits mean less money to invest in new deals."
But while most observers take a cautious approach to the sector for now, few foresee a calamitous decline approaching the dot-com crash of 2000. Pitchbook's Cook, for instance, says it's more likely that the sector will slip back to 2013 levels, when venture-capital firms raised about $24 billion from investors compared with the $37 billion expected to be raised this year.
SundayMonday Business on 01/03/2016