Shifting Dynamics of Venture Funding

© StartUp India/Government of India

As the pandemic began to unfold last year, a global VC fund famously wrote a letter to its founders and CEOs titled “Coronavirus: The Black Swan of 2020” warning them of potential drops in business activity, and the ensuing need to hunker down and conserve cash.

Across the industry, it was predicted that Covid-19 would be a great reset for many businesses. While this was true to a great extent, not many expected that 2020 would turn out to be one of the biggest years ever in venture capital with funds having deployed $141.9 billion in investments in 2020, according to a EY’s analysis of Crunchbase data.

Venture capital industry is constantly morphing, ever so slightly day by day. Change was afoot in the VC industry even before the pandemic, but Covid — 19 has undoubtedly been a catalyst for many changes currently being witnessed in the VC landscape. We are now looking at a vastly different playing field, with founders looking to capitalize on new opportunities created by Covid-19.

How did this year of great suffering and uncertainty turn into one of the biggest bull-runs in venture capital history?

A closer look at some of the global trends yields some very interesting answers.

Zoom investing: Zoom investing has accelerated the pace of deal making across rounds. Before the pandemic, negotiations were largely a face-to-face affair, naturally limiting the number of encounters between investors and founders. Meeting on Zoom and other video-conferencing platforms takes only a few clicks, allowing both founders and investors to talk to many more potential partners at a much more fervent pace than ever before.

Level playing field: Zoom investing and Covid-19 has levelled the Global VC and Start-up landscape further. Venture capital no longer has borders. Investors sitting in the US/EU can easily access start-ups across the world and remote investing has certainly removed some mental barriers from investors’ minds.

Quantitative easing: Covid-19 induced quantitative easing by governments and low interest rates have increased the dry gunpowder available to private investments. Low interest rates have been producing the best possible opportunities for early-stage start-ups.

Increasing interest from non-traditional investors: Another trend gathering strength globally, even prior to Covid-19, was that the non-traditional investors such as individual family offices, high net worth individuals began to embrace VC investments as a viable investment alternative. Post Covid, this trend has only accelerated.

All the above factors acting together resulted in an increase in pace of deals, increase in liquidity, increase in the round sizes at each stage, and consequently an increase in valuations. The Q1 2021 US VC Valuations Report from Pitchbook reports that early-stage valuations hit record highs with median and average pre-money valuations coming in at $40M and $96M respectively. Closer to home, we are seeing the one-unicorn-a-week phenomena unfolding over the last few months.

In many ways, Covid pulled forward the future that technology companies have been building towards. Consumer behaviors that would have taken years to go mainstream were normalized in a matter of weeks. Investors now are enthusiastically backing start-ups and technologies that will thrive in the new economy.

From here on, what could the future have in store for the industry? What are some of the macro level risks which we need to watch out for?

Inflation risks: Post Covid-19, the world has been witnessing a period of high inflation with increased supply of money in the market and one-off supply chain bottlenecks. While a few policy makers opine that this inflation is only transient in nature, other economists are pointing out that the central banks must tighten monetary policies and increase interest rates sooner than expected and at higher rates than they would have earlier preferred.

Tech rally fizzles out: Some of the present exuberance in tech VC investing is also caused by the broad rally seen by the market for tech stocks. However, some of the recent gains seen by tech stocks may be difficult to sustain in the long run as investors may divert funds to other fundamental industries post the pandemic. This may have a spill over effect on the money inflows into the tech VC industry.

Capital becomes scarce: If the above two risks play out, we might witness a dip in capital inflows for start-up investments in the short-term to long-term. All of these will have an impact on funding rounds, type of deals funded and the deal valuations.

Enough with the gloomy talk and coming back to the present, the VC industry is already off to a great start in 2021. There has never been more money available for great ideas. Competition among VCs for the best deals in the market is at its highest point ever.

All this leads us to one of the most profound impacts of the changing VC landscape: the shift in balance of power from investors to having a better balance of power between investors and founders. Traditionally, investors had the upper hand in the fundraising process. However, intense competition for deals and high supply of dry gunpowder has tilted the scales in favor of founders. VCs are now accepting of more generous terms, both monetary and otherwise.

The question for money-folk in venture investing globally is now beginning to be less about which start-up to invest in and more about whether a start-up will let you invest in them or not. And for founders, there are no shortage of problems that need solving across industries, from space travel to cybersecurity to health care and more.

Exciting times lie ahead of us!

Murali Krishna Gunturu
Principal, Inflexor Ventures