YesCOMPANIES everywhere were preparing for the end of the world in March 2020. Sequoia Capital, a large venture capital (VC) firmly, warned of Armageddon; others predicted a “great slowdown”. Airbnb and other startups have reduced their workforce in anticipation of an economic bloodbath. But within months the tribulation had subsided and a historic boom had begun. America unleashed enormous momentum; Tech company dominance increased as banned consumers began spending even more time online. Many companies, including Airbnb, took advantage of the bullish sentiment by listing on the stock exchange. American’s market cap VC-Assisted firms that went public last year amounted to a record $ 200 billion; It is expected to reach $ 500 billion in 2021.
With their pockets full, investors want to bet on a new generation of companies. Global venture investments – ranging from early “seed” funding for companies just starting out to funding for more mature startups – are well on their way this year, according to PitchBook, a data provider to hit an all-time high of $ 580 billion. That’s almost 50% more than invested in 2020, and about 20 times as much in 2002.
The type of investors who pile up in venture activity has changed dramatically as well. It was once the reserve of niche venture capital firms that operated in Silicon Valley. These raised funds from pension funds and other end investors and invested on their behalf, often relying on their extensive connections with company founders. However, only three of the ten largest venture investors by assets under management are now traditional VC Companies.
Instead, deals made, or concluded, by private equity firms, hedge funds, and others with little previous venture activity are well on their way to growing from $ 144 billion in 2020 to $ 260 billion. Dollar almost doubling this year (see chart 1). That’s an incredible 44% of the world’s VC Activity up from 20% in 2002. Crossover funds such as Tiger Global ManagementLocated between public and private markets, capital is deploying at breakneck speed. Behemoth pension funds are increasingly investing directly in startups.
The flood of money from capital investors has led to an increase in valuations. But it also flows into once neglected corners and new opportunities. The venture activities now extend well beyond Silicon Valley and America, funding companies working on everything from Blockchains to biotechnology.
The wave of capital is also changing the way VC functions. VC Companies are adopting new strategies to differentiate themselves in some ways and emulate their Wall Street competitors in others. This has both advantages and disadvantages for the innovation business.
The modern venture capital industry emerged in the 1960s from a laboratory at Fairchild Semiconductor, a chip manufacturer from Silicon Valley. Arthur Rock, who first left Fairchild to invest, raised $ 5 million in his first fund and returned $ 100 million over seven years. Eugene Kleiner and Don Valentine soon followed, forming Kleiner Perkins and Sequoia, respectively. Both are still big VC Company today.
The approach was to support risky startups in the hope that the big hits like Google would carry an entire portfolio. Seed investments were often made before a startup made any income. Then came an alphabet soup of successive rounds of funding, which typically ranged from series A to C., matured as a company. the VCs funds were closed, i. H. After their own cut, they distributed returns to investors, usually pension funds, foundations and other long-term investors, within seven to ten years.
Veni, vidi, vc
The venture capitalists didn’t just provide funding. They also played consiglieriwho often sits on the board of a company. They offered a wealth of experience and access to a network of contacts and, for example, introduced startups to professional managing directors. Entrepreneurs flocked to Sand Hill Road, home to much of Silicon Valley VC Companies hoping to get funding. The industry’s reliance on personal connections made it more of an old boys’ club.
The model turned out to be astonishingly successful. Even though VC-supported companies account for less than 0.5% of American companies founded each year; they account for nearly 76% of the total public market capitalization of companies founded since 1995. Over time VCs are increasingly opting for somewhat older “late” startups (which in turn delayed the IPO). Some VC Companies opened branches abroad. Andreessen Horowitz, also based on Sand Hill Road, was founded in 2009 and rose to the top.
Then why is the model disturbed? The frenzy is due to both the entry of new competitors and greater interest from end investors. This in turn reflects the decline in interest rates in the rich world, which has pushed investors into riskier, but higher-yielding markets. That helped without a doubt VC has been the world’s top performing asset class over the past three years and has performed on par with bull runs in private equity and public stocks over the past ten years.
End investors who have so far avoided VC get involved now. In addition to seductive returns, the selection of Star Funds for. be easier VC than with other forms of investment: a good performance tends to be more permanent, according to a study in Journal of Financial Economics released last year. Big Tech’s success, much of which was backed by VC Dollars, could have been another attraction. Investors may have previously underestimated the earnings potential of the tech industry, says Fred Giuffrida of Horsley Bridge, a fund that operates in VC Middle. They may correct this now.
The capital rush has pushed prices up. Venture activities for seed-stage startups today are the same as for Series A deals (for older companies that may already be generating income) a decade ago. The average funding amount raised in a seed round for an American startup in 2021 is 3.3 million US dollars, more than five times the amount in 2010 (see chart 2).
But financing is also entering new territory. In 2002, 84% of venture activity by value was in America. This proportion is now around 49%. China’s share grew from under 5% in the 2000s to 37% in 2018, before falling to nearly 20% due to its technical crackdown. Instead, capital has looked for greener pastures in Europe (see section Economy). Keith Rabois of Founders Fund, a vc firm, argues that investing in less heated sectors, when done right, can help generate attractive risk returns.
Software startups are still popular with venture capitalists. But “You are seeing an increase in donors,” says Josh Lerner of Harvard Business School. More risky biotechnology, crypto, and space ideas are supported. Moderna, a pharmaceutical company that makes Covid-19 vaccines, became Flagship Pioneering, a. outsourced VC Festivals. Green technology, which saw its boom and bust in the 2000s, is on the rise again. P.wC., a consulting firm, estimates that between 2013 and 2019, climate tech venture deals increased five times total startup funding.
For many old-school venture capitalists, this new world of competition is worrying. “We have to react,” admits Sequoia’s Roelof Botha. Although rising valuations increase the returns on current portfolios, they dry up future returns. Crossover funds are less price sensitive than traditional ones VCS. And for startups in the later phase, investors’ money is more fungible, says Giuffrida. It is less important who invests than how much they are willing to pay. In addition, the market is for Orthodox VC Company gets tougher. Despite the venture boom, fundraising through new niche VCs in America has fallen from a high of $ 14 billion in 2018 to an expected $ 5.5 billion in 2021.
Part of the traditional business answer is differentiation. Many crossover investors typically take a data-driven approach, building portfolios of startups that resemble an index of the top performers in each sector. They avoid playing large roles in their portfolio companies. In contrast, some VCs emphasize their personal touch. Crossover funds “are transaction capital. We are relationship capital, ”says an early-stage investor.
A fund in Austin, Texas, Jan.VC, is expanding its startup incubator, which currently promotes and spin-offs around five companies per year. Slow Ventures, another VC Companies, even investing directly in the career paths of individuals, such as online content creators, who may not already be running a proper business. Without a convincing offer, says Ben Horowitz, co-founder of Andreessen, VCs must either be willing to overpay or shut down altogether.
Another response is scaling. Some angel investors who invest their own money without a team or company are spreading their wings and becoming solo venture capitalists investing outside funds. You can act quickly – there are no other partners to convince before you close a deal. Elad Gil, a prominent solo VC, made around 20 investments in the first half of 2021 and launched a $ 620 million fund, an astonishing amount for a single investor.
The biggest and best known VC Companies are also expanding. Andreessen has expanded its investment team from around 25 to 70 over the past four years. It offers companies support in everything from diversity and inclusion policies to a huge network of potential new hires and customers.
The line between VC and other investors continue to blur as well, and not just because Wall Street is encroaching on Sand Hill Road. Big VC Companies are also becoming more like other asset managers. Sequoia is expanding its presence in public markets. In October she announced that her American and European venture capital funds will be housed in a larger, timeless fund. When portfolio companies go public, their shares go to the super funds and not to the end investors. This means that Sequoia can also search for a Initial public offering. Crossover funds like Tiger are already seamlessly transferring holdings from their private to public funds. Other great VC Companies can follow suit.
Sequoia’s Superfund reflects Wall Street’s fascination with permanent capital. “Much of the dynamics of the private equity markets are now spilling over into the venture capital markets,” says Lerner. VCs and private equity funds raised money from investors every few years, which can be costly and prevent them from holding onto investments. Leading buyout firms like Blackstone and KKR Found ways to get around this. Almost a third of that KKRThe assets under management are now permanent.
Sequoia is also becoming a Registered Investment Advisor, joining Andreessen and other large funds such as SoftBank. This allows him to hold more “secondary” stocks – stocks that are not bought directly by the issuing company. (VCS’s secondary holdings are typically capped at 20% of their portfolios.) Andreessen’s status as an advisor enabled him to launch a $ 2.2 billion crypto fund in June that primarily invests in digital tokens rather than startups.
The largest funds are best placed to capitalize on the new world. Promotion from above VC A company signals the quality of a startup, argues Mike Volpi from Index Ventures. And because non-traditional investors often rely on such signals to steer their dollars, their value has only increased. The result is that the industry has become more unequal: Though the average American VCAssets under management rose from $ 220 million in 2007 to $ 280 million in 2020, skewed by some big hitters. The median, less influenced by such outliers, decreased from USD 70 million to USD 48 million. But that’s not to say that the industry has been dominated by a few star funds. Market shares are still small. Tiger Global, for example, made investments worth 5 billion worldwide in 2020. Startups have sufficiently different needs that there is plenty of scope for a multitude of VC Companies exist, says Mr. Volpi.
For their part, company founders have gained bargaining power in the competition among investors. “There’s never been a better time to be an entrepreneur,” says Ali Partovi of Neo, a VC Company based in San Francisco. Ten years ago, most start-ups would not have heard of a term sheet, a document that describes the terms of an investment, says a venture capitalist. Many startups are now working with “accelerators” such as Yes Combinator to learn the basics. Cloud computing and other software-as-a-service (SaaS) tools allow some businesses to expand without large investments.
The time it takes to close a deal has shrunk from weeks to days, if not hours. Zoom has changed the way fundraising is done. Biodock, a microscopy startup, had ten calls with me VCs set in one day, which gave him more power in negotiations, says Michael Lee, its founder. Founders receive “refreshes”, i.e. increases in equity during the fundraising rounds. To forestall the onslaught, some investors are offering cash to companies before they even look for further funding.
The shift in power away from investors is to be welcomed in some ways. The oversized returns of VC Businesses are competing downwards. In addition, technology is no longer terrain that only well-connected venture capitalists in Silicon Valley can understand. The performance of SaaS companies can, for example, be assessed using data on user behavior. The relationship between founder and venture capitalist might be less important than it used to be, especially as the startup grows.
But there is also a cost. Shortened deals can be too FOMO (Fear of missing out) for investors and sometimes worse investment decisions, says Mr. Partovi. The change has also weakened governance. When the balance of power tips away from them, VCs get fewer seats on the board of directors and shares are structured in such a way that founders retain voting rights. Founders who make bad bosses – like Travis Kalanick, the former head of Uber, a transportation service company – can hold out longer than they should. The relationship between VC Companies and a founder take about ten years, longer than many marriages, notes Mr. Partovi. You wouldn’t be choosing your spouse anytime soon.
Another risk is that the market is too frothy. Some investors cite record profits for tech companies and the financial health of even the youngest startups as reasons for an optimistic view. But “Companies are valued on the assumption that everyone wins. Statistically, that’s not going to happen, ”says Giuffrida of Horsley Bridge.
Excellent returns for investors are therefore not guaranteed. The broader question, however, is whether the innovation taking place is worth the risk. “If too much money is being funded, that’s generally a good thing. It’s much better than no one funding Moderna, ”says Horowitz. And capital can drive new ideas, not just the other way around. Investors in the past have generally been willing to bet on riskier but more innovative startups, such as a study by Ramana Nanda of Imperial College London and Matthew Rhodes-Kropf of. shows WITH Sloan School of Management. Resilience, a capital-intensive drug company founded last year, raised $ 800 million and has already purchased several factories. That would not have been possible two years ago, says Drew Oetting of 8VC. Venture activities in the space sector grew by 70% worldwide to $ 7.7 billion in 2020. “There are more moonshots,” estimates Lerner from Harvard.
In technology, the result could be more vigorous competition. Big tech companies used to devour challengers: the acquisitions of Amazon, Apple, Facebook, Google and Microsoft rose after 2000 and peaked at 74 in 2014. Since then, however, they have fallen to around 60 per year in 2019 and 2020 . maybe out of fear of antitrust enforcement (see USA section). More and more startups are making it to public markets. Listings make up around 20% of a startup’s “exits” today, compared to around 5% five years ago.
Wherever the reviews go, it looks like the changes are in the structure of VC will take time. The excessive returns on investments in the early phase ultimately had to be reduced. As VC Companies themselves are forced to innovate; a wider range of ideas are supported in a wider variety of places. The pandemic wasn’t the disaster venture capitalists initially expected. Still, it changed what they do. ■
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Correction (November 29, 2021) A previous version of this article incorrectly stated that the average seed stage valuation for an American startup in 2021 was $ 3.3 million. In fact, this is the average amount raised in a seed round. We’re sorry.
This article appeared in the Finance & Economics section of the print edition under the heading “The next stage”