DataTribe Insights - Q3 2020: Signs of Stabilization

The DataTribe Team

The recent decline in early venture activity started in Q2 2019. The beginning of 2020 extended the decline, with Covid-19 adding additional pressure to the market through most of Q2, resulting in historic declines in venture deal volume across verticals. The asymmetric economic toll of the pandemic will permanently alter some industries, but Q3 marks the first signs of recovery for those industries bolstered by the pandemic, particularly cybersecurity. More broadly, venture activity is showing signs of stabilization, with early stage volume flat1. Seed and Series A valuations are down 2% and up 14%, respectively, compared with the same quarter in 2019. Cybersecurity valuations are mixed and highly variable over the last year.

It is important to again revisit the notion that early venture deal volume is a lagging indicator of investor appetite. Discovery and due diligence can take months. Building a trusting relationship can (and probably should) take much longer. The activity observed in Q2 was, for the most part, already in progress before the lockdowns. Our own investment in BlackCloak certainly was. Months ago, we started looking to Q3 as the first credible health check on venture capital. The diagnosis? Investors continued tightening their purse strings, extending a trend that started in Q2 2019, but remains active. US early stage deal volume is essentially flat from the previous quarter2.

Investors have shown increasing interest in cybersecurity and e-commerce startups in Q3 from Q2, with early stage volume up 29% and 23%, respectively, based on data captured at the end of each quarter. This aligns with the dramatic shift in consumer and business behavior (i.e. remote work) that began in the second quarter. E-commerce is well off its Q2 2015 peak of 97 early stage deals, but the Covid-induced collapse in foot traffic has created fresh opportunities for e-commerce. Cybersecurity deal activity is 52% off its more recent peak observed in Q1 2019 (53 total deals), but the Q3 increase is nonetheless significant. While adjusting investment processes to a remote work environment, capital in cybersecurity is both available and being deployed. This points to resilience in the cybersecurity investing landscape in the face of economic headwinds.

Continued growth in cybersecurity’s share of overall investment activity indicates significant investor appetite. In Q3, cybersecurity represented 19% of U.S. early venture activity, up from the previous high of 14.9% in Q2. The data suggests this is due to a combination of the increasing awareness and relevance of cybersecurity combined with a decline in other investment verticals.

Early stage valuations support the idea of a recovery in early stage investing, albeit with some ambiguity due to the high variance of investment size and valuations across rounds and verticals. A review of 2020 vs. 2019 Q3 deals shows median valuations for all verticals up 6.7% and 7.2% for Seed and Series A, respectively. Cybersecurity deal valuations are more variable, with Seed valuations up 33.3% and Series A valuations down 28.2%, respectively year-on-year. In looking at the five year valuation trend (refer to the the chart below), you can see a steady increase in cyber valuations while the quarter-by-quarter data shows more variability. The year-on-year decline in Series A valuations in Q3 2020 is likely due to a combination of the relative peak in 2019 as well as headwinds associated with the pandemic.

 

Cybersecurity is no longer an afterthought but a fundamental capability to ensure business continuity and protect consumers. A July 2020 McKinsey report states, “[cybersecurity teams] must no longer be seen as a barrier to growth but rather become recognized as strategic partners in technology and business decision making.”3 Bank of America recently emailed digital security tips to clients with a subject reading, “…Hackers are targeting home networks like yours.” Favorable momentum for the industry has been building for the last few years, starting with the awareness brought by the 2016 U.S. Presidential Election, then Crowdstrike’s $6.7B IPO, and now the shift to remote work. Cybersecurity is becoming a mainstream topic and capability. This bodes well for both investors and entrepreneurs and we expect the positive momentum to accelerate in the coming quarters.

1. Source: Pitchbook U.S. deal activity in all verticals for Early Stage Venture Seed & Series A 2. U.S. Seed and Series A deal activity in Q3 2020 is down 1.4% from Q2 2020 3. McKinsey & Company: A dual cybersecurity mindset for the new normal, 7 July, 2020