On the podcast: VC's resurgence, the IPO boom and what's in store for 2021

With one year of the pandemic behind us, Alexander Davis sizes up the venture capital market by looking at how dealmaking not only adapted, but roared back to life in terms of capital deployment, VC capital formation and exits and a banner year for initial public offerings by some of the biggest names in the business.

Listen in as PitchBook analysts Cameron Stanfill and Joshua Chao share key findings from the Q4 2020 PitchBook-NVCA Venture Monitor report, and the outlook for what's shaping 2021. We also feature guest commentary from Susan Winter and Devika Patil, both of Silicon Valley Bank, on what the recent data is telling us about the direction of the VC market.

Listen to all of Season 3 and subscribe to get future episodes of "In Visible Capital" on Apple Podcasts, Spotify, Google Podcasts or wherever you listen. For inquiries, please contact us at podcast@pitchbook.com.

Download the presentation or report, and watch the full Venture Monitor webinar here. Transcript Alexander Davis: Hello, and welcome back to another episode of PitchBook's "In Visible Capital" podcast, which takes you inside the inner workings of the private markets. I'm Alexander Davis, editor-in-chief of PitchBook News. Today, with one year of the pandemic behind us, we're taking measure of the highs and lows in the venture capital market. As market conditions recover from the crisis, we'll hear from PitchBook analysts and a few guests about what has been working and what isn't.

After a scare in the first half of 2020, the venture capital market is rolling into 2021 on an upbeat note. While investors faced some dire conditions surrounding the pandemic, the venture ecosystem has largely escaped a once-in-a-century public health emergency. More than that, investors have claimed big wins in terms of record-setting fundraising, deal flow and exit activity. It's worth remembering that just one year ago at this time, the idea of pulling off such a feat could not have seemed more remote.

Alexander: [In] March 2020, financial markets around the globe are in a panic. In a moment that captures the bleak outlook of the early weeks of the crisis, Sequoia Capital sounds an alarm to its portfolio companies. They call the pandemic a black swan event that threatens to upend global economic growth trends. Sequoia wasn't wrong—much of the world economy was shut down. A deep and long-lasting recession quickly followed, but a modest economic rebound has finally begun. Even before that, the venture market showed signs mid-year of bullish activity that has carried through to now.

Venture capital dealmaking not only adapted, it roared back to life in terms of capital deployment, VC capital formation and exits, punctuated by a banner year for initial public offerings by some of the biggest names in the business. To break down what has been driving the action, we'll hear from PitchBook analysts who cover the venture asset class. We've got highlights from our team's review of market conditions featuring findings from the latest PitchBook-NVCA Venture Monitor report and the outlook for key trends in 2021.

Our analysts, Cameron Stanfill and Joshua Chao, led a panel discussion delving into what the recent data is telling us about the direction of the VC market. As Josh explained, venture capitalists kicked off 2021 having just had a record year of fundraising totaling over $73 billion. That was done with just 320 different fund vehicles, the lowest number since 2013. "The industry's huge haul is the result of major thematic trends driving the market climate," Joshua said.

Joshua Chao: There's a little more going on here. What really bolstered 2020's robust fundraising was threefold. First, loss of public market liquidity from a strong IPO market; second, near-zero benchmark interest rates; and third, frankly, a large number of LPs were underallocated to venture coming into the year, with distributions going back to LPs at record levels. This justifies the increased allocations. When we look a little deeper at the various fund sizes, we see that mega-funds, so these are funds that closed at least half a billion dollars, also had a great year in 2020. A record 44 of these mega-funds were closed in 2020, with 14 of these VC funds at $1 billion or more.

Some notable funds raised in 2020 include a pair of funds, totaling $4.6 billion from Andreessen Horowitz back in November, Tiger Global's $3.8 fund from the very beginning of January of 2020, NEA's $3.6 billion fund from March right as the pandemic really set in, and General Catalyst's $2.3 billion fund a month after that. While established managers like these four were able to find success in 2020, this story did not apply to all fund managers, particularly emerging managers. We saw a fundraising bifurcation in 2020 between established and emerging VC firms.

Typically, emerging firms—and these are characterized as those that have raised fewer than four funds, typically—these emerging firms raise twice the number of funds as established firms simply because there's just so many of these smaller, newer and younger firms. However, if you're an emerging firm, with maybe one or two funds under your belt, not much past fund performance to tout to LPs, 2020 was certainly a challenging year for you. We see in this graph that fund counts between emerging and established firms was essentially at parity rather than a 2:1 ratio that we've seen over the last several years.

This represents a 50% year-over-year decline in funds raised by emerging firms. Naturally, this expands the chunk of the pie that established firms are able to take. This slide shows that established firms—again, established firms are those that have raised four or more funds—they exceeded 70% share of the fund value for the first time since 2014. As established managers found more success in raising flagship funds during the pandemic, emerging firms had had to be more creative and think about non-flagship financing vehicles such as rolling funds, syndicates, commingle funds, SPVs, etc. 

What's interesting to note here is that only 50 first-time funds were raised in 2020, which the total was just shy of $4 billion in capital. This is a sharp decline from 2019's $6 billion, and 2018's $10.8 billion raised by first-time funds. Next, when discussing fundraising, we also find value in looking at the amount of capital overhang or dry powder that's available to VC-backed companies. As of March 31, 2020, dry powder is currently sitting at an all-time high of $153 billion. You can see the breakdown of dry powder by vintage here. While the dry powder is building, this likely needs to be deployed as well. 

Alexander: Let's turn to what could be the hottest topic of all, the stunning rebound in initial public offerings. These days, no discussion about the bull run in IPOs is complete without getting into the rise of blank-check companies known as SPACs. SPAC deals raised more than $75 billion in 2020, a figure that is already being overtaken in 2021. Venture capital firms initially kept their distance from SPAC deals, [but] soon the allure of this vehicle became too hard to resist. As Josh Chao explains, many established firms are jumping in.

Joshua: One interesting thing to note was the involvement of VCs in the formation of their own SPACs. Investors like FirstMark, Lux Capital, 5AM Ventures and Ribbit Capital are some of the firms that are looking to integrate SPACs into their stack of financing vehicles. Whether they use it as a means of taking portfolio companies public, or simply having a stake in the equities market, that remains to be seen.

Alexander: Our guest Devika Patil, a managing director with Silicon Valley Bank, commented that SPACs have come on strong, in large part as a response to many unicorn companies' difficulties going public through the traditional IPO process.

Devika Patil: My favorite topic [is] SPACs; we couldn't read the daily financial news without the word SPACs popping up last year and continuing on to this year. I could go on; Susan and I could talk about this for an hour or so. I'll try and keep this as succinct as I can. I think it's really important. As Joshua mentioned, we saw 320% more SPACs raised in 2020 than were raised in 2019. I think it's really important to understand what was happening in 2019 before this SPAC surge in 2020. Part of this could be attributed to the struggles that unicorns were seeing, whether it was Lyft, Uber, Slack, they went public earlier in 2019, but then didn't trade that well in the latter half.

Then, of course, there was the well-known debacle of WeWork, which we also know now is talking to a SPAC ... and VC firm ... so it will be very interesting to see how that progresses. I think the scrutiny that was put on WeWork just made a lot of companies a little shy of IPO and put their IPO plans on hold. With the IPO market becoming more difficult for these companies, just the market became more price-sensitive and selective. I think this is where SPACs saw the opportunity. With IPOs, IPOs have seen very little innovation in the last few years, and for some companies thinking about going public, SPACs can be a really useful way to raise capital quicker and with fewer hurdles.

They give more price certainty to founders, and they let the founders evaluate, do they want the short-term investors that may be part of the first day pops that we've seen with some of the IPOs in December, or do they want longer-term investors who are more interested in the growth strategy? Susan and I did an interview with Reed where he used SPACs as an opportunity to venture at scale. The IPO is not the end of the journey; it's the beginning of the next phase. How do you want to position yourself with your investors in that journey of your company. Another issue that was brought to light is the S-1.

For high-growth companies, you can't incorporate financial projections, but with a SPAC you cannot incorporate those financial projections. It just gives you more solid price certainty and more rationale when you go out to price. In terms of how these facts fit into the ecosystem, I definitely think it's another way of providing exit optionality for VCs. For unicorns that maybe earlier on in their go-to-market strategy or their customer acquisition story, where they may not have scaled economics yet, I think it provides a great mechanism. There's over $725 billion unrealized unicorn value just in the US alone. When we think of the potential that SPACs have for 2021 and beyond, it's just remarkable.

Alexander: Susan Winter, head of loan syndication at Silicon Valley Bank, took measure of the non-equity forms of financing that have a significant footprint on the VC deal landscape today.

Susan Winter: Yes, it's interesting. Venture got in the many different non-equity access to capital that VC and growth-stage, late-stage companies have from either the bank to the non-regulated lenders, to then once they're public, then the conversion field. I'll talk a little bit about the trending that we're seeing around that. A lot of the trends that we saw on banking changed a lot as we saw 2009 on with Volcker and Dodd-Frank when we started having more regulatory scrutiny. That created a whole ecosystem for debt funds to get more actively involved in lending on either a highly leveraged or what we have been thinking about is the venture capital. That has created a proliferation of debt funds ways that did not stop in 2020.

We believe it's going to continue in 2021. What we've seen is access to capital in the debt terms. Oftentimes we saw a little bit of a pullback from the venture capital-backed companies during the first quarter of last year. Part of that is, some of the people really taking a hard look at what is the cash-flow mechanics. It's more of a debt play, making sure you're coming in. You don't have equity in the game, and you're making sure that you've got the right of provisional structures in place. We saw a little bit of a pullback.

For the syndicated loan market, we did see a drop, [a] 31% decline. I think in technology, there was a 17% for the middle market. Then in the venture debt area, we did see it soften. We had a lot of refinancings, but it continues to be strong and we believe it's going to continue even higher this year.

We're looking at an all-time low. Last year at this time, it was 1.67, it's now 0.21. We're also seeing mostly folks that are interested in putting in data placements for non-dilutive effect. Access to capital is so strong right now in all of the investors, but when they start to really tighten up the way they're looking at their full capital structure, putting in non-dilutive capital has been probably one of the biggest focuses that they continue to have. We're seeing bigger and bigger checks being written for that in the second half of 2020, and we see that continuing on. As we think about some of the big fundamentals that are out in the market, the convert market, although it's equity is equity linked to debt, this was white hot at the second half of the year. 

We saw a huge amount of public companies accessing it, and then the high-yield markets accessed it and started to roll back as well. We're now seeing single V and double V credits being priced at 3% to 4% to 5%, which is an all-time low. We're seeing there's massive amounts of support either from institutionals, debt funds and banks as well. We do believe that the banks continue to be monitored heavily by the regulators. There's smaller debt sizes and more structuring next to each other. You've got the right protocols. Then the venture debt area that you spoke on at the beginning, we're seeing there's a couple breakout players within that area at larger funds that are really being active in this space. Some of them were taking $20 and $30 million debt instruments. 

Some of them are now either depending on the company and the cash flow fundamentals or pre-cash flow fundamentals. We're seeing some checks being written as high as $600 million for some companies that are looking to get in place. Again, staying on the message, we've seen just as a lot of little liquidity out in the markets and competition's strong in a lot of these funds. Some of the funds, BDCs that are just monitored on the public market, but some of the funds are private, but they don't put capital to work. They [...] send it back. They're all very active, and we're seeing the property market where we're seeing compression and pricing to the benefit of the borrowers. They're being able to get better terms than ever before.

Alexander: In the depths of the pandemic, venture capitalists honed in on portfolio companies that were thought to be the most resilient in the face of the crisis. This selectivity ushered in the flight to quality that has lasted into 2021. Venture deal flow during the pandemic bifurcated, into haves and have-nots, leaving some big questions looming over the market outlook. Once again, here's Susan Winter.

Susan: Just hitting on fundraising, it was a huge year. But then the early stage, we did see a drop-off a little bit. It seemed that investors and exit strategies really focused on persistent revenue growth year-over-year, and really on that ramp and that path to success. So much that we've seen in this industry has really been winner takes all. This huge ramp, when that is seen with some of the huge, huge decking unicorns or the unicorns themselves really have then been able to dominate in this space. That has been the biggest principle that we've seen across it. Then within those sectors, we often look for some continuity or stickiness in the revenue.

If it's recurring revenue we're looking in security, artificial intelligence, any enterprise software areas that really have that high stickiness when it's actually done. Instead, in a cloud, changes are done by a push of a button effectively versus having to come into on-premise services, where you have to do a rip-and-replace to make some huge modification. We're also seeing the trends as Devika had touched on and really see more around edtech, all the things that happen during COVID that changed our lives forever in various capacities. Edtech has been a huge impact, social media, the wellness area and wellness, whether it's in teledocs or others, or the remote doctoring or support for individuals. Then in fintech there's huge growth as well.

Alexander: To understand the present, it's helpful to think of 2021 as a year divided into two parts. Early on, it was bleak for company founders. It was dominated by a climate of fear that saw VC funds tighten up capital deployment. That left record sums of dry capital accumulating, but businesses began adapting to the new normal, and the pendulum swung back in favor of founders. Deal valuations are once again being driven up as investors scramble to put their names on term sheets. This has reshaped dealmaking and VC fundraising into 2021. Let's listen to Devika Patil's commentary on that and the rise of big new software players that are themselves becoming corporate investors in the VC ecosystem.

Devika: We've seen software valuations now trading at 18 times enterprise value. We're seeing high-growth companies trading at 25 times, and growth rounds are being compared to public comps at about two to four times. Really a great place to be. Now in 2021, there's light at the end of the tunnel with vaccine distribution. I think we're seeing a lot of the similar factors that we saw in 2020 play out in 2021, specifically fundraising, with a lot of LPs allocating profits and distributions from 2020 IPOs they're allocating more to venture. I think the fundraising environment remains robust.

As Joshua mentioned there's enough dry powder that's still willing and able to be deployed back into the system. Where's this going to be deployed. Because of COVID, we've seen a great acceleration of digitization.

We've seen the cloud market grow. We've seen the virtual enterprise that's poised because of remote work and edtech, etc. That's poised for a lot more innovation in 2021, and also there's the healthcare market. [For] companies that are the intersection of technology and life sciences, LPs are willing to allocate a lot more, and COVID's just moved that towards the forefront. Another factor is the mega-funds and the mega-deals. CVCs have come in, and they're not only participating in deals, they're leading deals. We're seeing newly formed public companies or private companies, whether it be CrowdStrike, Snowflake, Slack, they're starting their own CVC funds, and they want to see this ecosystem. We're going to see a lot more deals flow from there as well.

Alexander: It's fair to say that venture capitalists and their portfolio companies have demonstrated a high degree of resilience to the havoc wreaked by the pandemic. But there are some big questions facing the VC ecosystems for the rest of 2021. For instance, are limited partners going to continue allocating more capital to this asset class? Will SPAC deals be a dominant feature of the IPO market, or will more late-stage companies go public through more traditional routes?

My PitchBook colleagues and I will be watching closely and we look forward to sharing our insights with you. That does it for this week's episode of PitchBook's "In Visible Capital" podcast. Thanks for listening.