The Cannonball EffectPeter Wagner | February 1, 2022
We are operating in a time of great change – in both the venture industry and the startup world itself.
Dramatic Increase in Capital
One striking change is the massive influx of capital into the startup ecosystem. The amount of venture capital invested globally has increased 256% from 2016 to 2021. In the US, it has increased 302% over the same timeframe. The average deal size is up 2.5x globally from $9.2 million in 2016 to $22.8 million in 2021 and is up 2.75x in the US from $9.0 million in 2016 to $24.7 million in 2021. The number of deals, after four years of slow growth (and substantially slower than the growth in capital), surged by 25% globally and by 30% in the US from 2020 to 2021.
It is true that much of the increase in capital invested has flowed into some very large later-stage financings. But when we zoom in on early stage financings in the US, we still see similar trends. Dollars invested in Seeds have increased 249% from 2016 to 2021, and dollars invested in Early Stage (generally Series A’s and Series B’s as categorized by PitchBook) have increased 227% over the course of this period. The average Seed and Early Stage deal sizes are up 2.2x and 2.3x, respectively, from 2016 to 2021. The number of deals grew slowly from 2016 to 2020 but surged from 2020 to 2021 by 16% for Seed and by 46% for Early Stage.
So what is attracting all this capital? Exits are a big part of the answer. Global exit volume has increased more than 800% from 2016 to 2021, both globally and in the US. One of the major questions around the sustainability of the large capital inflows into venture has always been whether there will be enough large exits to deliver a suitable return. Thus far anyway, the answer has been yes, and this, in turn, attracts even more capital. The scarcity of attractive returns in many other asset classes has also an important factor, of course, although this may change with the rising interest rates moving forward.
The growth in venture exit volume is part of a broader phenomenon in which technology assumes an ever-larger role in the global economy. One measure of that is the increasing proportion of the US public market cap accounted for by the technology sector. This has grown from 18% in 2016 to 31% in 2021. When you consider the scale of the numbers involved, this is a big step up.
The Cannonball Effect
Most of the additional capital flowing into the venture ecosystem is coming from non-traditional new entrants, such as public market investors, hedge funds, PE firms, sovereign wealth funds, etc. As an illustrative case study, we looked at the new deal activity of Tiger Global. The chart below shows first-time deals by Tiger (not including follow-on investments), and categorizes them by stage. Tiger greatly accelerated its pace in 2018 and 2019, and began to include earlier stage investments with meaningful frequency. The firm pulled back a bit in 2020, but is now investing more aggressively than ever, with 251 deals in 2021, up more than 5x from 2020.
Tiger Global is the largest but not the only new entrant driving change in the venture industry. Again for illustrative purposes, we looked at the new deal activity of a group of 10 selected firms including Tiger. The 10 firms are relatively new to the venture market and have high and ramping volume. Altogether the group of 10 firms had 527 first-time deals in 2021, up more than 3x from 2020 and almost 22x from 2016. The 10 firms’ 2021 investments span across the range of Series A’s, B’s, C’s, and D+’s and even include an increasing number of Seeds.
Of note, Tiger Global is indeed the Goliath in the group. Its 2021 first-time deal count of 251 is almost half of entire group’s deal count of 527.
The capital being deployed by these 10 and other similar investors is having a major impact on the structure of the venture industry. Looking back a few years, we see a picture where different types of investors were reasonably focused in their respective swim lanes. It was an orderly scene.
Like that big guy at the party who launches a giant cannonball into the swimming pool, the massive influx of capital from new types of investors has really shaken things up. These cannonballs are making a lot of waves! The well-defined swim lanes are largely gone. Different types of investors are expanding their strategies and encroaching on the strategies of others.
- Large public market and PE investors have become big factors in the private markets, playing heavily in growth stage deals and going even earlier, leading a substantial number of Series A and even seed investments.
- Growth stage investors have also begun investing earlier, motivated at least partially by a search for lower valuations given the frenetic run-up in later-stage deal pricing.
- The major venture brands, for their part, have made a big push into mid and later stage investing. Quite a number of them operate some of the most successful growth funds, and routinely invest in as many Series B’s and C’s as they do A’s. These firms are also trying to ramp up their seed investment practices, some of which were actually de-emphasized or even shuttered in the prior decade.
- The Seed firms, for their part, are trying to play longer, leading Series A’s and making significant follow-on investments in their star companies out of opportunity fund vehicles.
The main event here is the collision between the public market and PE investors investing earlier, and venture brands investing later while also trying to hold their early stage high ground. Some observers have noted that these two types of investors are “playing different games”, making the point that the later-stage investors have lower return thresholds, and are therefore willing to pay higher prices than the traditional venture capitalists. There is truth to that, but it’s not the whole story. Public market centric investors are also using their early stage investing to gain access to later stage deals in those same companies at a later date, and to gather information which can benefit their large later stage and public market investing practices. The majority of their capital is actually deployed in these later stage and public strategies, and there is a lot of leverage if early stage activity can improve later stage deal flow and market intelligence.
With the pressure on public market valuations to start 2022, one can question whether the public market centric investors will continue to invest as aggressively this year as in previous years. Although it is premature to make a prediction or conclusion, there are numerous scenarios. As a late stage investor commented to us last week, late stage financings continue to occur at premium valuations, but there are one or a few lead term sheets at the full price now as compared to several or numerous at the full price a month or two ago. Another scenario is a bifurcation of the market, where star companies continue to command a full valuation but where other companies, who have had a relatively easy financing path over the past few years, face a more challenging environment.
For startup founders, this time could not be more exciting, and more fraught with unforeseen risks. Capital is more available than ever, and from a widening array of sources. These sources have vastly differing contributions to make. Some make no contribution at all (other than their cash), and pitch that as a positive! The best founders will think through the implications of various financing paths, and focus on the long game. The end goal should not be to “win the deal”, but to build a great company. A “cannonball financing” can be part of a winning strategy, but should be deployed only when a company has already built a solid foundation. Do you have product market fit? Have you demonstrated an efficient go-to-market model? Do you have a team that can scale? When these lights are turning green, you might consider using capital as a weapon to dominate your category. But if you over-capitalize prematurely, you may destroy your opportunity to build something great. The best early stage investors help their founders build that solid foundation, and then facilitate the cannonball financing when the time is right. The net effect is a new type of company trajectory that combines company-building craftsmanship with the power of capital-at-scale.
1) The 2021 # deals and $ invested reflect PitchBook data as of January 31, 2022 and will increase as more deals that occurred in 2021 are publicly disclosed, identified, and recorded in Pitchbook over time.
2) The Tiger and Selected Firms’ deals exclude the PE Growth/Expansion deal type in PitchBook. The Seed and Series designations are based on PitchBook’s Deal Type, Deal Type 2, Deal Type 3, Series, and Deal Synopsis data.
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