April 20, 2017
Joanna Glasner is a business and technology columnist covering all things venture capital. She was previously a reporter for Wired and Reuters.
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After years of buzz and modest consumer uptake, it was supposed to be the time when virtual and augmented reality came into its own.

VR startup funding hit new highs in 2016, with both newcomers and established players raising investment for hardware and VR-enabled content. New product offerings from Oculus, Google, and others hit the market in 2016, while the smash hit Pokemon Go proved consumers would flock to compelling augmented reality experiences.

Yet instead of raging on, the party looks like it’s slowing down in VR startup-land. Let’s see what 2017 may bring.

Venture Appetite

VCs are showing a diminished appetite for virtual and augmented reality startups this year compared to last. Both the number of funding rounds and total investments made into the space have slowed down in Q1 2017.

According to Crunchbase data, a total of 26 companies with AR or VR-focused businesses raised a disclosed funding round in the first quarter of this year. Together, the firms raised just over $200 million in Q1 2017. That result compares to 29 companies in Q1 2016 raising just over $1 billion. Q1 2017 also marks the lowest quarterly number of financings and investment total in over a year.

In the chart below, we look at financings totals for augmented and virtual reality startups for the past five quarters. The spike in Q1 2016 is largely due to a single financing, a Series C round of nearly $800 million for cinematic VR technology developer Magic Leap. That single round is more than four times the size of any other VR-related funding.
Round counts are another good indicator of investor interest in a space. For the following chart, we looked for augmented and virtual reality companies that have raised a round valued at $100,000 or more. While we’re still seeing seed and early stage investors active in the space, the number of completed deals is trending down this year.

What Changed?

We can’t assert with great confidence that slow VR uptake among early adopters is dampening investor enthusiasm. The space is small enough that fairly random quarterly fluctuations, such as a late-stage company closing a round a couple months later than expected, can move the needle on investment totals. The massive Series C round for Magic Leap last January was also a uniquely large round for the space, and it is not likely it will be repeated. Additionally, it should be noted that 2016 funding for VR was unusually high overall, by both round count and investment totals, dwarfing prior years.

The universe of well-funded VR companies is also a limited one. An analysis of Crunchbase data found that there are least 28 private, venture-backed companies that have raised total funding of more than $20 million and closed a round in the  last few years. Of those, about half closed their last round in 2016.

Still, there’s some disappointing news about the nascent market for VR technology lately that could be turning off investors. Facebook-owned Oculus, for instance, hasn’t delivered on expectations. The VR gaming system developer closed hundreds of live demo stations at Best Buy stores earlier this year due to lack of customer interest. It also recently slashed prices following below forecast sales.

Magic Leap, the highest profile venture-backed VR company, has also been getting some bad publicity. Reports claim that company’s technology has been oversold to investors.

Overall, the global VR industry posted mixed results last year, as initial sales volumes by some high-end manufacturers didn’t live up to the hype, according to a new report from research firm Greenlight Insights. Low cost headsets did better, with the PlayStation VR and Samsung Gear VR among the top sellers. Greenlight expects VR will make good progress in coming years, however, and will grow into a major global market by 2021.

Exit Drought

Another factor that could be holding back VR investment is a paucity of exits.

Facebook provided a spectacular return for early Oculus investors in 2014, paying $2 billion to acquire the company, an early stage startup at the time. There hasn’t been a deal with anything close to that dollar amount since, nor have we seen IPOs of VR-focused companies. Of course, that could change in a heartbeat should Google, Facebook, Samsung or any number of other deep-pocketed tech giants active in VR find an appealing target. And Facebook, at its F8 conference this week, certainly signaled an expanding interesting in the space with a slew of AR and VR-related announcements.

Nonetheless, for now, it looks like investors are increasingly in wait and see mode.