In recent years, there has been immense growth in the number of venture capital mega funds, which are defined as funds valued at a minimum of $100 million. Total funding in the United States increased from $32.6 billion in 2014 to $71.9 billion in 2017. However, the significant increase in capital did not increase the number of deals. On the contrary, the number of deals dropped 4% in 2017. Co-founder and CEO of CB Insights Anand Sanwal described this outcome as the “SoftBank Effect”.
SoftBank, the largest player in the mega funds landscape, invests a minimum of $100 million in each of its portfolio companies from their gigantic $100 billion vision fund. To put that in perspective, the Y Combinator plans to raise only $1 billion and Sequoia Capital plans to raise only $12 billion.
SoftBank raised the capital from Apple, the UAE government’s investment fund Mubadala, and most notably Saudi Arabia’s Public Investment Fund who invested $45 billion. With that money, the mega fund has invested billions in several unicorns like Uber, WeWork, and Slack. Despite their 16 investments in 2017, SoftBank had zero tech investments in 2014.
Masayoshi Son, founder of SoftBank, explained that the company’s large entrance into the tech market is to be prepared for the day when artificial intelligence is smarter than humans.
However, other factors have propelled the creation of these mega funds like the increased availability of capital from sovereign wealth funds and cash-heavy companies. Unicorns, like WeWork and Slack, are also staying private for significantly more time, resulting in larger financing rounds from the unicorns. Since SoftBank’s minimum investment must be $100 million, they target established startups like these to hedge their risks.
As a result, more capital is raised but is increasingly distributed towards the larger companies. With a decrease in deals, unicorns receive a larger share of the funding, raising one quarter of all funding in 2018. Companies that are not unicorns are further disadvantaged by the extreme pressure from the mega funds to produce at least 10x returns. With the large available amount of capital, they are expected to expand and hire rapidly. As a result, the companies potentially adopt risky models that make it impossible to make profit and pay back their debts.
Despite this setback, venture capital funds will surpass $100 billion in 2019 according to Claudia Zeisberger, Senior Affiliate Professor of Decision Sciences and Entrepreneurship and Family Enterprise at INSEAD. Similar to SoftBank’s disruption, Zeisberger forecasts that China’s will overtake the United States in VC capital investments. Due to China’s high growth rate and high investor enthusiasm, they are expected to invest $102 billion in 2019 compared to the United States’ projected $94 billion. However, after the shock IPO announcements of Uber and Lyft, the future of venture capital mega funds is far from certain.