MGCS Industry Insights – U-M’s David Brophy: Equity-market Turbulence and Shifts in Investor Sentiment Reshape the Venture Capital Industry in 2015

Shannon Beeman
March 2, 2016

Join us for the 35th annual Michigan Growth Capital Symposium (MGCS) to take place on May 17 & 18 at the Marriott Resort in Ann Arbor/Ypsilanti. In addition to providing a platform for Midwest startups to pitch investors; the two-day conference will feature two keynote speakers, several panel discussions, a technology transfer pitch session and ample networking opportunities. More than 450 investors, entrepreneurs and related stakeholders are expected, with nearly 75 investment firms represented. The deadline for presenting company applications is Thursday, March 10. Apply online. Register to attend at

In the weeks leading up to the Symposium, the Zell Lurie Institute will highlight a new topic around growth capital each week. Learn about the topics surrounding venture capital from leaders in the industry who take part in MGCS.

David Brophy, Zell Lurie Institute University of Michigan RossTurbulence in the U.S. equity markets coupled with the realignment of investors and the emergence of new investment strategies has turned the tide in what had become an exuberant and frothy venture-capital landscape throughout much of 2015, according to David Brophy, professor of finance and director of the University of Michigan Center for Venture Capital and Private Equity Finance, or CVP.

“The sharp decline in the equity markets in August and early September took a little bit of the shine off the runaway excitement about early-stage companies and the heavy use of the private market by large investors looking to take stakes in start-ups while they were private,” Brophy says. “Until the market sag, attention centered on the $1 billion-plus tech ‘unicorns’ and their sky’s-the-limit pre-money valuations. Then suddenly, we had a few IPOs that went public at valuations considerably less than their last private valuations. That was a big shock to some people.”

Mutual funds, which had joined the rush of venture investors pouring money into high-flying VC-backed private companies, later pulled the plug after these companies went public. “Mutual funds consistently mark to market (by valuing assets at the most recent market price) and want to see after-tax profits in the companies they own,” Brophy explains. “They took big markdowns on Internet and high-tech companies that had gone public and were still not generating the level of cash flow and profits they wanted to see.” Subsequently, venture-backed start-ups with headline-grabbing IPOs saw their share prices plummet once they were listed on the public stock exchanges, and this further accelerated the equity markets’ swoon.

Despite the pullback, valuations remain stubbornly high in both the venture-capital and private-equity business, according to Brophy. This has put investors between a rock and a hard place. “While PE firms now see this as a good time to sell out the companies they’ve invested in, they find it difficult to rationalize paying 10 times earnings for companies they otherwise would have bought for 5 or 6 times earnings,” he says. “In the venture business, there are still VCs who are willing to make big bets on high flyers, but the general tightening has affected many smaller firms.”

As the IPO market has sputtered, acquisition has become the favored exit for venture investors. “Although the market for initial public offerings has been relatively hot for the last few years, it was almost nonexistent for the prior decade,” Brophy says. “I think people have come to believe that the IPO market is a sometime thing, whereas acquisition is a steady path to harvest.” Typically, acquisition opportunities attract two types of buyers: strategic buyers such as large corporations; and financial institutions, such as private-equity firms, which buy a company, make operational and other improvements and then sell it to a strategic buyer or take it public.

Another growing phenomenon ─ the tendency for corporations to use venture-capital investment now as a substitute for their historic R&D activities ─ has put a new twist on the industry. “We are seeing the creation of corporate VC divisions that are reviving what used to be called ‘intrapreneurship,’ and are incentivizing their own employees to create value-generating start-ups within their companies,” Brophy remarks. Using an internal model, global manufacturer Robert Bosch has launched its own division that invests venture capital in high technology or services in the technology area. GM Ventures, in contrast, has adopted an external investment philosophy by investing in start-ups originating outside General Motors.

There’s an upside and a downside to the entry of corporate VCs into the market. “On the one hand, this is stimulating because corporations are looking for add-on and bolt-on companies and for technologies they can meld with their existing technologies internally,” Brophy observes. “By the same token, if corporations are building start-ups internally, this could depress their appetite for buying other venture-backed companies.”

In short, the venture-capital landscape is changing and evolving in ways that will have significant, but unpredictable, consequences. “Venture-capital investors now have a new collaborator, the large corporate VC, and both will always need the other,” Brophy concludes. “We’re entering a new phase where we’re focusing on things each investor can do to dig up new deals and turn entrepreneurial ventures into solid businesses.”

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