Investment in high-growth startups reached never-before seen levels in 2021 and, save for some risks of headwinds, the pace of investment doesn’t look like it is about to slow down in 2022.
What makes these startups attractive is that they are developing innovative technologies to address today’s and tomorrow’s challenges. Climate change, for one, has spurred an energy transition away from fossil fuels and towards renewable energy and cleantech. The coronavirus pandemic, and social distancing as a precautionary measure, highlighted the need for virtual collaboration and digital health offerings. Artificial intelligence and machine learning, internet, enterprise software, consumer tech, information security, fintech and blockchain, internet of things, mobility, energy tech, retail, supply chain and biotech/life sciences are just a few examples of continued high-growth sectors.
There is also an exorbitant amount of capital in private investors’ coffers that needs to be deployed within a certain period, depending on each fund’s mandate. Venture capital (VC) has enjoyed one of the highest private returns to investors of any asset class and returns Limited partner (LP) investors have received are being put back into VC funds. As a result, U.S.-based VC funds alone raised a record-shattering $128.3 billion in 2021, representing a 47.5% year-over-year increase over 2020’s fundraising figure of $86.9 billion, PitchBook data shows, with most of that investment going into existing managers.
It’s not just traditional venture capital firms seeking to invest in startups. The types of cash-rich investors that are making VC investments have grown, deepening the pool of capital sources available to fund and scale them.
More and more corporations – both private and public – are investing in startups as a form of external innovation, either by setting up corporate venture capital funds (CVCs) or off their balance sheet. According to Pitchbook, in 2021 corporates participated in $144.5 billion in venture capital investments in the U.S., doubling the $77 billion deployed in 2020, which had been a record year. Corporates invested in over 3,600 deals in 2021, a greater than 50% increase over 2020, and deals in 2021 that involved corporates made up nearly half of all venture deal value. More than 1,800 unique corporate investors made a deal in 2021, nearly 400 more than the previous high. And more CVCs are expected to enter the market in 2022. In addition to capital, corporates can bring additional value to emerging companies looking to scale, including technical and operational expertise and know-how, R&D and manufacturing resources, commercial opportunities and business networks.
Private equity firms – flush with trillions of dollars in dry powder – are moving down-market to invest in earlier-stage companies, and hundreds of special purpose acquisition companies (SPACs) are racing against deadlines to find startups to take public. Even mutual funds and hedge funds, which historically focused on investing in public companies, have joined the fray.
As a result, venture capital investments soared to an astonishing $329.9 billion across 15,500 deals in 2021, up dramatically from $166.6 billion – the previous record high – across 12,173 deals in 2020, according to PitchBook data. Every subcategory of startup company – seed & angel, early- and late-stage companies – received record-high amounts of capital.
Even startups that had never raised venture rounds before were able to get in on the action. PitchBook notes that 4,000 startups raised their first venture round in 2021, collectively raising $23.8 billion – with the number of startups and the deal value both reaching record highs.
As could be expected, the abundance of capital and competition for deals helped drive up valuations. According to PitchBook, average valuation step-up multiples grew to a record 5.1x by the third quarter of 2021, Before the pandemic, in 2019, the average multiple was 2.6x and stayed at that level in 2020.
Competition has also led to a proliferation of early-stage megadeals. Around 104 such mega-deals were completed by the third quarter of 2021 – a significant jump from the previous full-year record of 61 in 2020, PitchBook notes.
Late-stage VC-backed startups, meanwhile, received more than $220 billion in capital during 2021 across more than 5,000 deals during the same period.
Investments done at higher valuations accelerated the creation of “unicorns,” or startups valued at more than $1 billion. In fact, more unicorns were created in 2021 that in the past five years combined, PitchBook reports.
Venture-backed portfolio companies have provided returns to their investors through exits, either by going public or being acquired. Through the end of 2021, total exit value was over $770 billion, a 168.0% year-over-year increase, across broad growth in the number of exit deals, soaring to more than 1,800. The majority of the dollars were from public listings, indicating strength in company valuations as well as public markets and attractive routes to going public, including IPOs, SPACs and direct listings.
This unprecedented deal-making environment has kept law firms busy advising startups on their myriad funding options and growth strategies. To illustrate, in the past 12 months alone, Baker Botts counseled more than 120 startups through partnerships with The Ion and Capital Factory, accelerators in Houston and Austin, respectively, providing them with over $100,000 of in-kind legal services.
And speaking of Austin, VCs invested $4.9 billion in Austin startups in 2021, a whopping 211.2% jump from 2020, in 387 deals in 2021, a 126.1% increase in the same period, according to PitchBook. In Houston, startups received over $2 billion in VC funding, an increase of 175% from the $734 million raised in 2020, in 219 deals in 2021, a 26.6% increase in the same period.
There are, however, potential headwinds on the horizon for VC activity in the U.S. Technology companies’ performance post-public offering has lagged the S&P 500. The Federal Reserve has signaled it will start increasing interest rates to try to control inflation. Regulators, including the Securities and Exchange Commission, are increasing disclosure and registration requirements for private funds and publicly traded companies. Antitrust and acquisition restrictions could limit exit opportunities. Supply chain issues and labor shortages threaten to dampen growth. And the war in Ukraine is creating volatility and uncertainty in the public markets, after a shaky start to 2022.
Nevertheless, investor interest in startups is not expected to dissipate, in part thanks to the continued outperformance of VC portfolios and the high amounts of dry powder in the hands of venture capital and non-traditional investors, including CVCs, looking for investments in 2022.
Publisher’s Note: This content is premium subscriber thought leadership. Baker Botts will be delving into this topic in its upcoming SXSW panel titled “Disruptive Technologies: How Innovation is Confronting Global Challenges” to be held at the Hotel Van Zandt in Austin on March 14. To see the full agenda and register for the event, please click here.