Venture capital: It’s not all gloom and doom in 2016

As I predicted last year, online education continued to gain momentum. A record $1.6 billion of investment was poured into education technology across 161 companies in just the first half of 2015. On the other hand, Internet of Things software platforms and services didn’t own the spotlight as I thought they would; it was IoT hardware, led by Fitbit’s IPO, which continued to drive headlines.

So far, 2016 has been volatile and it seems all we hear in the media is gloom and doom. However, I think it is very important to avoid panic and to take a thoughtful look at the long-term fundamentals of technology innovation to truly predict what we will see for the rest of 2016 and beyond. This year, we’ll still hear the familiar words: cloud, marketplaces and virtual reality, but I expect these sectors to take new shape as late stage investors’ increase their focus on revenue, growth and a path to profits. 2016 will be the year we will see late stage and public investors flee to quality companies and take fewer risks on unicorns with no business models.

1. A shrinking unicorn population. The list of unicorns, start-ups with valuations $1 billion or more, continued to grow in 2015, but 2016 will bring these companies into a new light, which won’t be as flattering. Many unicorns will continue to stay private and seek out new capital infusion from investors. However, financings will become much more challenging and founders and CEOs who seek the unicorn bragging rights will find themselves getting onerous financing terms like ratchets, participating preferred, and aggressive liquidation preferences. Some will get down rounds and some might not make it at all.

I predict the list of unicorns will shrink and that remaining list will be populated by network effect businesses with revenue, growth, and even profits. Historically, network effect businesses have generated the majority of the gains in venture capital, especially around consumer tech, and 2016 will be the year when VC’s realize that history will repeat itself. The stronger the network effect, the stronger the company’s position will be in the market. As Michael Moritz said, “you cannot defy gravity.”

Aggregate valuations among this stable of unicorns will actually grow but wealth will be much more concentrated among the few who prove that they have a durable business. The unicorns that will continue to thrive are those that have strong backing, great leadership, are customer-obsessed, and most importantly, prove their revenue model and path to future profits —think Airbnb, Uber and Palantir.

2. IPO market window stays ajar (for a lucky handful). While 2015 delivered the worst IPO year for VC-backed companies since 2010 and there’s a lot of talk that the IPO market will continue to deteriorate further in 2016, I do expect the IPO market to remain somewhat open, but incredibly selective. Tech companies with strong financials in particular will be a key driver of momentum later this year — think Airbnb.

As we’ve already seen this year, the U.S. market is off to a slow start, so betting on companies with tried and true business models and high profit margins will remain of utmost importance for investors. Additionally, as China continues to face challenges in its own market, particularly around lack of transparency and deflation, I predict more Chinese investors will refocus their attention to the U.S. market — and therefore, fuel capital to the U.S. technology sector.


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