A Closer Look at Deal Term Trends and The Regional VC Market
We are often asked what trends we are seeing in the data for deal terms, and why it is important. Thankfully there has been standardization of deal term structure through widely accepted forms such as the NVCA's model legal documents, including the Enhanced Model Term Sheet that was launched by NVCA in partnership with Aumni this summer. This growing trend towards uniformity in data reporting will open up the ability to see larger trends, but also allow individual firms to glean valuable data relative to their peers. Recently, Aumni participated in a virtual event hosted by VentureUP, an accelerator network for rising VCs investing in the Midwest, supported by TriNet, an HR management company located in California. We had the opportunity to sit down with a panel of industry veterans to discuss this topic in greater detail. In addition to sharing more about our NVCA initiative and results so far, we heard some interesting insights from other experts on the merits of tracking deal term data, what the data can tell them, and what they are seeing in regional markets.
The benefits of gathering and interpreting deal term data
After several months of data collected on deal terms, many firms are beginning to see patterns and insights. Joel Martin, Partner and Head of Operations at HealthX, shared that tracking and keeping an eye on the deal term data points gave his team the ability to see where they were relative to other firms and other deals. “The main ones that we looked at were the size of equity rounds, in terms of percentage, and how that compares to [deal source]". This better access to data and trends, together with regular updates to the data and terms measured, means more informed decisions for VCs.
Mike Brown, Corporate Law Partner at DLA Piper, shared that terms do tend to change over time. “I've done this long enough that I've gone through both the dot-com era, the dot-com bubble bursting, the great recession, and now today. After the dot-com bubble burst, and the recession, liquidation preferences drastically changed. They went from non-participating preferred as the substantial norm, to seeing a lot of participating. We saw a lot of full ratchets, [leading to uncertainty where the market is]. This time around, with respect to the pandemic, I have not seen the drastic shift in economic terms. Deals became a little bit more friendly to the investor.”
Mike went on to explain that the data behind these deal terms would go a long way towards boosting efficiency. The more we can understand what the market terms are, acknowledging any market inconsistencies, the better we can pinpoint the baseline and isolate differences in particular companies or investor deals that drive efficiencies to getting deals done.
Thoughts on participation rights
Another area where examining trends can be useful is participation rights. Joel offered that their fund would be able to spot anomalies by tracking the data across a statistically significant number of deals. For example, for a pool of 100 deals per quarter: if the norm is 10 percent of deals across the previous two years with participation and in the first quarter after an economic event, such as the pandemic, suddenly 30 or 40 percent have participation, having an alert to that trend in the data would be extremely useful. Perhaps even helping to shape subsequent deal negotiations to say, "The reality is the market is shifting to participation being the norm, so we may be able to get that into a term sheet in the subsequent quarter," said Joel.
Joel went on to share that the deal data they have collected has affirmed some of their assumptions: “It varies from stage to stage, but only around 10 to 15 percent of equity rounds have participating preferred shares. Looking at the model spurred us to look back at our deals, but it took me only about 10 minutes with Aumni to find out which deals had participation, and how much. There were four of our 15 companies where we had participation.”
Regional insights into the Midwest market
While the VC market has traditionally seen a bulk of the deal flow happening on the West coast, the allocation of deals by region has been growing beyond Silicon Valley. There have been some interesting developments in the Midwest region of the U.S. HealthX is based in Madison, Wisconsin and their network spans the country, with 15 companies in their portfolio right now. Two of these companies are on the East Coast, approximately six on the West Coast and the remainder in the middle of the country in various places. Hence their deal flow ends up being similarly spread out. “Not a ton of difference on all the terms, but valuations are definitely inflated in the Bay Area relative to what we see in the Midwest [in the context of] a particular amount of revenue milestones. The expectations from companies that are coming to us from the Bay Area tend to be between 50 and 100 percent higher than a similar stage company revenue-wise, in the Midwest,” offered Joel.
While some have noticed an increase of deals in the Midwest, not all have shared that experience. Mike shared his observations: “I have experienced differences between West Coast deals versus New York deals. I noticed differences with corporate strategics, or international deals. I see those deals as more focused, perhaps on corporate governance related terms, than you would get in a typical VC deal. But with respect to the Midwest versus Silicon Valley, I haven't noticed differences. In a limited sample size, I would say I have noticed differences with respect to the sophistication of the angel investors. Where I usually see angel investors in California, most of them are fairly sophisticated and understand most of the venture related terms. In some instances that I've noticed in the Midwest, that hasn't been the case. This has caused some issues that have ultimately been resolvable, but really disconnect with respect to expectations of the investors. Understanding that dilution and how future liquidation preferences may impact their investment [are some examples].”
We asked the group their thoughts on the ecosystem in general, in particular when it comes to the availability of capital for later stage rounds in the companies. Joel offered some interesting insights for timely verticals:
“There's a lot more bubbling up in terms of the earlier rounds. Minneapolis has a really vibrant health tech scene [with] devices coming from Medtronic, and health tech coming from the UnitedHealth Group [for example]. Those two very big companies end up pushing a lot. And they're active and interested. Both of them are quite active in the analytic survey, and both have their own accelerators that they've funded and so forth. Wisconsin has a number of growing accelerators, as well as organizations such as MATTER in Chicago. Those are in the type of the areas we invest in. In other areas such as Boston, there's been venture [activity] around biotech and sciences for a long time. It's newer in the Midwest, so we're seeing it and we try to work on supporting it, but it's definitely working up from the bottom.”