Expansion-stage market trends and creative exit strategies

By Heather Gates, Audit & Assurance Private Growth Leader, Deloitte & Touche LLP, and Kevan Flanigan, Deloitte Private Risk & Financial Advisory Leader, Deloitte Corporate Finance LLC

Talking points

• Expansion-stage exit financing has slowed considerably since the frenetic peak in 2021.
• Uncertainty around when liquidity may begin flowing again has motivated many expansion-stage companies to choose a creative exit alternative.
• Deloitte’s latest Road to Next report explores these creative exit strategies, along with market trends, which we also highlight in this edition of the Pulse.

To understand where the expansion-stage exit funding market may be headed, it helps to know where it was as recently as 2022 and where it is today.

In 2021 and much of 2022, exit liquidity flowed like water, leading to exorbitant valuations and record exit activity. Then came interest rate hikes and a spike in the cost of venture capital (VC), private equity (PE), and corporate capital. Rate hikes not only staunched the flow of liquidity, but also brought valuations and exit activity back down to more conventional levels—where they’ve remained for the past 18 months.

Market trends and direction

Fortunately, this year the market has shown signs of a comeback. Exit value in the first half of 2024 rose considerably, with hot companies in key industries such as software as a service (SaaS), artificial intelligence (AI), and machine learning (ML) seeing excellent valuations.¹ These numbers are likely skewing the broader market, making the recovery look stronger than it is.

Other market trends worth noting include:

• Liquidity preference: In 2021, dealmaking liquidity was roughly 1.2x. Now we’re seeing a preference of 2x to 3x.² These ratios indicate that it’s still an investor’s market, with deals closing on investors’ more stringent terms.
• Rearview mirror effect: Many owners of expansion-stage companies have experienced what we call the “rearview mirror effect.” They realize that past market conditions were not only distorted but are now well behind us. As a result, many owners are no longer looking for sky-high prices in exchange for liquidity and may now be willing to accept lower valuations.
• Equilibrium: The expansion-stage financing market seems to have reached a needed point of reconciliation or equilibrium in which valuations are in line with expectations. As in the past, pricing dynamics now come down to competition and what leverage can be applied in making a deal.
• Due diligence: The market has also made a return to robust due diligence, strong deal preparation, and well-documented financials and operations compared to 18 months ago.

Creative exit strategies

Some expansion-stage companies have taken a wait-and-see approach to exits during the liquidity slump, leading to an exit backlog. But others have opted for a creative exit alternative. Two that we’re seeing most often are inside rounds and down rounds.

Inside rounds: Inside rounds increased sharply in 2023 and continued into 2024. A more efficient way of fundraising, inside rounds are deals in which existing investors represent at least half of all participants and whose lead investors are existing investors. We’ve also seen a trend toward VCs choosing from two to four companies where they hold board seats to better position themselves to provide inside round funding. With conditions still favoring investors, VCs and PE firms are being selective about which of their portfolio companies receive inside rounds.

Down rounds: During the liquidity downturn, flat became the new up, leading to a rise in down rounds—funding at a lower valuation than the previous round. More expansion-stage companies began to accept VC down rounds in 2023 and 2024. More than 20 percent of all VC expansion-stage deals were down rounds in the first half of 2024, up from 18.4 percent in 2023—marking the highest share since 2013.³

Industry sector trends

As for industry trends, multiple $1 billion transactions closed in the SaaS, life sciences, AI, and ML verticals in the first half of 2024. These deals helped SaaS and life sciences deliver the highest expansion-stage exit value, while AI and ML recorded the strongest growth. This robust activity reflected interest in innovations like glucagon-like peptide-1 (GLP-1) obesity treatments and AI-enabled software platforms—the latter technology gaining momentum in several industries in 2024.

Market expectations for the second half of 2024

The market has already priced in rate cuts beginning in the fall. This expectation has fueled growing optimism for higher valuations and more favorable pricing in the fourth quarter. With considerable “dry powder” on hand, VCs, PE firms, and other investors are eager to deploy this capital with a “use it or lose it” mindset. The November election may have an even greater influence on the market than interest rates. Capital markets dislike uncertainty, so simply having House and Senate races settled, with policy positions understood, will likely create substantial market movement.

What role can Deloitte play?

Want to learn more about expansion-stage exits? Read Road to Next, our quarterly report on emerging investment trends in private financial markets and the venture capital ecosystem. Deloitte understands these markets and provides a range of audit and assurance services to meet their needs. Feel free to reach out to us with any thoughts and questions.

Endnotes

¹ Deloitte, “Exit avenues: The era of inside and down rounds – Q3 2024,” Road to Next series, 2024.

² Ibid.

³ Ibid.

The services described herein are illustrative in nature and are intended to demonstrate our experience and capabilities in these areas; however, due to independence restrictions that may apply to audit clients (including affiliates) of Deloitte & Touche LLP, we may be unable to provide certain services based on individual facts and circumstances.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.

About Deloitte

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as “Deloitte Global”) does not provide services to clients. In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the “Deloitte” name in the United States and their respective affiliates. Certain services may not be available to attest clients under the rules and regulations of public accounting. Please see www.deloitte.com/about to learn more about our global network of member firms.

Copyright © 2024 Deloitte Development LLC. All rights reserved.