Q3 VC Report: In Los Angeles and Beyond, Investors Focus on Quality Over Quantity

Key takeaways:

• Exit activity saw a major uptick nationally, recording the second highest exit values on record in Q3.
• Local exit flow was the second lowest going back to 2014, but experts say there's little reason for concern
• L.A. saw fewer deals in Q3 than anytime since 2016, but also the highest amount of capital invested since that year, showing a preference for quality over quantity
• 2020 is on pace to establish a record high for total capital raised for VC funds, but big funds are having most of the success while smaller funds are struggling

Despite predictions of a black swan event amid the worst pandemic in a century that shows little sign of improving soon, venture capital exit activity saw a major uptick in the third quarter, according to the PitchBook-National Venture Capital Association (NVCA) Venture Monitor released Tuesday. Dealmaking and fundraising were both also robust in Los Angeles and beyond.

"L.A. had a very strong quarter," said PitchBook VC Analyst Kyle Stanford. "Los Angeles has completed the third highest number of deals in 2020, behind only San Jose/San Francisco and New York."

If there was weakness to be found, it would be that much of the action is taking place at later stages and bigger funds, not the younger companies and newer funds that dominate Los Angeles. Seed fundraising was anemic in the last quarter. Through Q3, $1.9 billion has been raised across 30 first time funds representing a record low of 3.3% of total capital raised.

Los Angeles saw the fewest number of deals in Q3 since 2016, but also the highest amount of capital invested since that year, mostly due to the nearly $2 billion Elon Musk's SpaceX raised in August. Companies that flourished during the stay-at-home economy also benefited, such as Zwift, a Long-Beach based online fitness platform that raised nearly half a billion dollars in Series C funding last month.

Investors say they were determined to focus more on quality over quantity, paying a premium to fund top startups for the long haul.

"This continues a trend that we were experiencing before COVID, which is larger seed rounds to support a longer runway," said Mark Mullen, co-founder and managing director of Bonfire Ventures, a Santa Monica-based B2B seed fund that closed a $100 million second fund last month. "Now with COVID and its current and unknown long-term economic effects investors are focusing even more on fewer companies and providing more runway to those companies."

As the stock market surged in the third quarter, companies like Snowflake, Palantir, Asana, and Unity had wildly successful IPOs, putting this year on pace to a record year for exit values, behind only last year.

L.A. saw a number of significant exits like Signal Sciences, which was acquired for $775 million in August. Blockfolio, a financial management platform, was acquired for $150 million in August. Sense360, a data insights platform, was acquired for $44 million last month.

But overall exit flow was the second lowest going back to 2014, except for the fourth quarter of last year. Still, investors caution that quarterly data should always be taken with a healthy dose of salt.

"It is just a quarter out of tens of quarters," Mullen said. "Deals go up and down in different periods. We have had three profitable exits in the last six months in L.A., which is our most in a six-month period. M & A in the world was way down in Q2 and Q3 due to COVID and is now having a resurgence."

Mullen added an optimistic note. "You may see a record Q4 and Q1 2021," he predicted.

As LPs seek out growth in a low-interest rate environment that looks like it will last for years, venture funds have raised a record $56.6 billion across 228 vehicles since the beginning of the year, which is already more than the $54.9 billion raised in all of last year. But big established funds like Greylock Partners Fund XVI of $1.0 billion and Meritech Capital Partners' Fund VII of $817.9 million are eating up most of the pie, while first time funds face a "herculean task" to raise capital, according to the NVCA.

"The consolidation of capital continues toward larger, later stage companies and established VC funds," said Bobby Franklin, president & CEO of NVCA, in a written statement. "While both of these trends are potential signs of concern for the long-term health of the VC lifecycle, overall the ecosystem has shown strong resiliency in the past six months."