Nothing ventured, nothing gained
Important evolving trends in venture capital markets
Despite the rocky start to 2020, venture capital (VC) funding hit an all-time high. U.S.-based, VC-backed companies raised nearly $130 billion in 2020, up 14% year-over-year (YoY) from 2019. However, annual deal activity is down 9% YoY to 6,022 deals, with seed deals getting hit the hardest (Chart 1). Mega-rounds drove the funding gains in 2020, with 318 rounds worth $100 million or more taking place in 2020, setting a new record. Mega-round deal share was roughly half of total funding in 2020 at 49%. As of year-end 2020, there are 225 U.S.-based, VC-backed private companies valued at $1 billion+, with a record 28 companies reaching unicorn status in the fourth quarter of 2020 alone.1
The drop in deal velocity seen in the U.S. VC market over the back half of the year was similar in Canada. In the third quarter of 2020, the Canadian Venture Capital and Private Equity Association (CVCA) reported Canadian companies raised $891 million over 126 deals, compared with $2.4 billion across 130 deals in the third quarter of 2019 (Chart 2).
Although CVCA numbers are not yet in for the fourth quarter of 2020, we expect a continuation of the decline in VC funding. Pitchbook data, albeit not perfectly in sync with CVCA data, offers insights into the direction we should expect from the CVCA fourth-quarter numbers. Pitchbook data shows 125 Canadian companies raised $1.0 billion in VC funding during the fourth quarter of 2020 compared with 195 companies raising $1.5 billion in the fourth quarter of 2019 (Chart 3).
It is clear that VC funding is starting to trend down, especially when you exclude mega deals. But what about exits? It is safe to say that VC exit activity is on a tear, with a massive comeback in the back half of 2020 that has been predominantly driven by the public markets. In 2020, U.S. VC exits totaled US$290 billion, surpassing the record of US$257 billion set in 2019 (Chart 4). Traditional IPOs and alternative go-public structures, such as Special Purpose Acquisition Companies (SPACs) and direct listings, were a major driver of this exit activity.
At the start of the year, the IPO window ground to a halt as the world came to grips with the Covid-19 pandemic. However, as second-order effects of the pandemic, such as the increased need for digital payments, ecommerce, and work-from-home solutions, became more apparent, the public market appetite for late-stage technology companies that would benefit from these trends seemed insatiable.
This public market demand was clearly evident from looking at the record-breaking SPAC numbers. In less than a year, this four-letter acronym financing structure came out of relative obscurity to show up on every late-stage company’s radar as a legitimate go-public path. In 2020, 250 US SPAC vehicles raised over US$75 billion, which represented a five-fold increase compared with the record year posted in 2918 (Chart 5).
As is usually the case in any sharp market movement, the SPAC craze came out of a perfect storm of events. First, for years, public market investors have been mostly on the sidelines as private technology companies accrued value in the private markets. Second, the aforementioned tailwinds of Covid-19 brought more attention to platform companies that enable digitization for both businesses and consumers. Third, some high-profile early-stage investors have been quite vocal (Bill Gurley being one of the most vocal of all) on the many principal-agent problems that are inherent in the traditional IPO process
So you have the fear of missing out on the next wave of innovation, propelled by a successful media campaign that has culminated into a never-before-seen run into SPACs.
However, we are starting to see some signs that the supply of SPACs is reaching saturation. Some examples include Cerberus Capital Management, which downsized its latest US$400 million SPAC to US$250 million, while Gores Holding, one of the most active sponsors to date, cut its US$535 million offering to US$300 million. Undoubtedly, the current SPAC craze will bring to market companies that shouldn’t otherwise be public. And investors across asset classes must be cognizant of the potential aftermath when the music stops.
However, we do believe that the increased focus on alternative paths to going public is a positive market development. Further, it looks like the U.S. regulatory bodies are also supportive of these alternatives paths as highlighted by the recent SEC direct listing rule change, which will allow direct-listing companies to raise primary capital.
It seems innovation and change are not limited to the companies we invest in, but also extend to the financial markets in which they operate. The Pender Ventures team is lucky to be supported by PenderFund’s public market investment team, and as such, we believe we are in a unique position to help our portfolio companies navigate this quickly and ever-changing landscape.
1. Source: PWS Money Tree Report Q4 2020
Kenndal McArdle, CFA is Principal, Pender Ventures, the private technology company investing arm of PenderFund Capital Management. This article first appeared in the Pender Ventures blog. Used with permission.
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