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March 24, 2005
Overhang Is Shrinking
VentureOne released its latest overhang survey today. Overhang sounds like a painful toenail condition, but it's actually the amount of uninvested capital that's idling in VCs' kitties. Two years ago, everybody was nervous about the overhang because VCs had raised so much lucre in the foamy days and then practically stopped investing it. In response, lots of firms cut fund sizes (if they hadn't already spent the management fees). Now the overhang is waning and "will continue to decline," says VentureOne analyst Matt Garlick. However, VCs are still sitting on a sizable lump of un-invested follow-on capital (money that they plow into their portfolio companies in subsequent fundraising rounds). That partly explains why late-stage valuations have been rising.
Out of all the U.S. VC funds raised since 1999, $53.6 billion, or 29%, hasn't been put to work yet. That's down from the $68 billion overhang that VentureOne reported last year. Given that VCs invested $20.4 billion last year--up from $18.9 billion in 2003--the current amount of leftover money isn't too alarming. However, VCs started raising new funds at a rapid pace last year, and they'll continue to do so this year. The future of the overhang will depend on VCs striking a balance between money raised and money invested.
Of the current overhang, $32.7 billion, or 61%, is earmarked for investments in new portfolio companies. But if we zoom in on funds raised in 1999 and 2000--the two biggest fundraising years in VC history--we find that 100% of the money left in those funds is for follow-on investing. Not surprising, you say, given that those funds are five and six years old (VCs invest in new companies during the first three to five years of a fund's ten-year lifespan and then continue to fund those companies through the remaining five to seven years). Sure, but VCs raised big funds back then not only because startup valuations were bubblicious but also because they expected to pay bubblicious prices in follow-on rounds. VentureOne found that 20% of the money raised for year-2000 funds remains un-invested--that's $16.5 billion in follow-on money. Clearly, not all VCs have cut their fund sizes.
That portion of the overhang has helped jack up late-stage valuations in the past year. Life sciences companies have gotten particularly pricey. But even in info tech, the median late-stage round was $22.6 million last year, up from $16.6 million in 2003, VentureOne says. Other factors have driven up late-stage prices, too, especially the recovery in the IPO and M&A markets. But until the vintage 2000 overhang burns off, expect to see some steep price tags on five- and six-year old companies.
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