Are we in a venture capital bubble?
“We weren’t looking to raise money, but an investor preempted our turn and now we are raising a $ 15 million Series A at a pre-money valuation of $ 150 million with minimal income. We are already oversubscribed and plan to close the cycle by the end of this week. ”
For anyone working in venture capital in 2021, this is a common story. Nate Williams, co-founder and general partner of Union Labs seed fund described the market as “SPEED! In 2020, most due diligence cycles were definitely condensing into weeks but recently we are seeing fundraisers come together in days often before their official “start”. A fast-paced and competitive funding environment, combined with a booming stock market and accelerating rise in valuations at every step, has left many people wondering, “Is this a bubble?” How long will it last?”
While seasoned investors have spent 2019 warning of an impending “winter”, COVID was anything but a cooling mechanism in capital markets. In fact, it was the opposite. Public markets and technology multiples set records at the start of 2021. 50 venture capital-backed companies listed on the stock exchange in the first quarter of the year, 5 times the historical average. According to data from Pitchbook-NVCA, early-stage pre-monetary average valuations have already doubled from $ 60 million in 2020 to $ 110 million in 2021. Late-stage valuations have risen even more. spectacular, increasing almost 4 times to an average of $ 1.6 billion.
While shocking to live with on a day-to-day basis, in the absence of widespread fraud or a massive public market correction, the current momentum is likely to continue, and here’s why:
1. Businesses are growing faster than ever.
Valuations are measured on the promise of rapid growth. In fact, businesses are growing faster than ever, thanks to the acceleration of fundamental changes towards cloud-based solutions, automation and the future of work. According to Bessemer’s State of the Cloud report twenty years ago, it was typical for a subscription business to take ten years or more to reach ARR $ 100 million. Today, companies like UIPath and Slack are getting there in just a few years. This speed of scaling is also reflected in the ratings. In 2013, a unicorn was a rare breed, but in 2021 a new unicorn is struck every day.
2. We are in the midst of a fundamental shift from public to private markets.
“Private tech companies are bigger and older than ever. Instead of being a bubble, it’s more of a reallocation of public capital to private companies, ”said Marcelino Pantoja, startup founder who previously worked at Stanford University’s investment office, and most recently at Tribe Capital. Pantoja pointed out that, according to Morgan Stanley, rising IPO costs, increased access to private capital, and lower infrastructure costs for scale-up have pushed companies to stay private more. long, increasing the median age of a company by 50% since 2001..
3. Within private equity, venture capital has outperformed.
According to a recent report by Michael Cembalest of JPMorgan Asset Management, the 10-year median annualized returns on venture capital are higher than those for buyout, real estate and private credit funds. Exceptional returns from recent liquidity events, low interest rates and favorable policy winds have only increased the attractiveness of venture capital as an asset class, accelerate the transfer of capital from public to private markets and motivate traditional and non-traditional private investors to increase allocations to venture capital funds.
4. Funds increase, so do checks.
Traditional market investors, whether asset managers or hedge funds, typically have billions of assets under management and are therefore looking for increasingly larger investment vehicles through which they can deploy significant capital in the market. capital risk. As a result, nearly 50% of new venture capital is managed in funds greater than $ 1 billion. Fund managers carve out the lion’s share of their returns on deferred interest, which is only earned after the fund returns, so there is an incentive to write bigger and bigger checks in the hope of being able to recover. the fund from a good investment. Bigger checks mean more dilution for founders, unless valuations increase by a corresponding amount.
5. This has created a significant imbalance between supply and demand.
The rise in valuations can logically be explained by the fundamental dynamics of supply and demand as investors’ thirst for alternative private investment has grown, but the supply of risky firms has remained. stable. “Subsequent rounds take place over a shorter period of time, as the multi-stage deep water tries to get ahead of competitive processes. I’ve seen Series B investors contact the founders within days of announcing their Series A, ”says Michael Cardamone of Forum Ventures (formerly known as Acceleprise). Without any dramatic reduction in start-up costs, like the advent of a cloud-based infrastructure like AWS ten years ago which removed significant barriers to starting a business and therefore led to a boom in business. supply of companies backed by venture capital, this supply / demand imbalance is likely to persist.
Venture capitalists have no choice but to adapt to a changing market.
Investing in start-ups is a journey filled with crossroads, and navigating the new world of venture capital requires a balance of strategic adaptation and discipline. Many entry-level managers like Williams at Union Labs specialize and focus more on building networks where they have a sustainable competitive advantage. “We have always been super focused and thesis-oriented. In our areas of deep technology concentration, we have built extensive investor networks among Series A / B companies, venture capital firms and various independent angel investors, ”said Williams.
Later stage managers increase fund sizes and create seed programs, incubators, and other mechanisms through which they can build relationships with founders over time before making a big investment. Managers like Cardamone have launched pre-seed accelerators. “We review thousands of companies each year and invest in 50 to 60 pre-seeded SaaS companies per year, so we had to develop the processes and infrastructure to move quickly to reviewing a high volume of companies. “, did he declare. “It makes us very nimble in this current market when we see a company we love but the cycle is moving quickly. “
The headlines suggest that due diligence cycles have been squeezed, but in reality there are many cycles unfolding today after months of relationship building, market observation, and endless backchannel referrals. A cycle that runs quickly is just the culmination of small jobs done over a long period of time.
Where do we go from here?
There has never been a more exciting and frantic time for venture capital, and the asset class remains one of the most promising available to investors today. Only time will tell if this is truly an asset bubble or not, but for now current trends should continue.