Fundraising Trends for Technology Companies: Outlook for 2022
January 01, 2022
As the United States continues to weather the COVID -19 pandemic, technology and life sciences companies continue to innovate and venture capital (VC) firms have certainly not curtailed their investment activities. VCs learned to virtually meet with founders, perform due diligence, negotiate term sheets and close investments. The fear of missing out on the next great tech company is quite evident with VCs competing to close deals and term sheets at a frenetic pace.
Venture Capital Activity
As of the writing of this article, the books were not yet closed on 2021; however, many annual records relating to venture capital activity were already broken -- and by a significant margin. Through the first nine months of 2021, full year records were set for dollars of VC investment, dollars of VC-backed exit values, fundraising and dollars invested in mega deals or deals of $100 million or more. Despite the entire world dealing with COVID-19, including the most recently discovered Delta and Omicron variants, VC investing topped the following high water marks, according to Pitchbook’ s Q3 2021 reports on venture capital and private equity:
- VC investment for the nine months ending 9/30/2021 totaled $239 billion, which eclipsed the annual record of $166 billion.
- VC-backed exit values were $583 billion through the first nine months of 2021 and this more than doubled the prior annual record of $289 billion.
- VCs have raised $96 billion for the nine months ended 9/30/2021 and this shattered the prior annual record of $85 billion. In all likelihood, 2021 will be the first year that VC fundraising has topped $100 billion.
- VC investment in mega deals totaled $136 billion through the first nine months of 2021 and this represented about a 77% increase over the prior full-year record.
Private Equity Activity
Private equity, the asset class that includes venture capital, has experienced similar record-breaking performance in 2021. With the year not yet over, the private equity asset class has already achieved annual records in terms of private equity investment ($788 billion); private equity exits ($638 billion); fundraising ($315 billion) and private equity buyouts ($944 billion), according to Pitchbook’ s Q3 2021 reports on venture capital and private equity.
Even with private equity investments at record levels, there is still approximately $800 billion of “dry powder” waiting to be invested and that does not take into consideration a fundraising environment that is showing no signs of slowing down. Much of the limited partner capital flowing into private equity funds is the result of large financial institutions (i.e., pension funds) looking for significantly higher returns in a very low interest rate environment. In fact, several larger private equity firms are actively in fundraising mode now and are projected to raise individual funds as large as $20 - $22 billion. Despite threatened inflation and the possibility of the Federal Reserve increasing interest rates in the near future, it certainly looks like private equity funds will continue shopping for U.S. companies in 2022 and beyond.
Two of the fastest growing areas of the economy, health care and technology, have always attracted attention for earlier stage dollars from VCs but are now also getting attention for larger dollars from private equity. In an environment of low interest rates, high stock prices and an economy encouraging consolidation, these stable businesses with high growth rates are definitely encouraging a lot of transaction activity now.
Fundraising and Investment Trends to Focus on in 2022
During the past two years, we have seen a surge in VC investing and strong competition between firms to get into the best deals. This competition has very much influenced the valuations for VC deals at all levels of the life cycle. Within weeks of the initial cases of COVID-19 in the U.S., the government provided hundreds of billions of dollars of stimulus payments to small businesses and to individuals and technology firms began to flourish, as both companies and consumers spent even more of their time in a virtual environment. In the near future, the market will continue to be impacted by the COVID-19 pandemic and how the government responds to the fiscal and monetary challenges, here in the U.S. and also globally. Many of the business process changes that we have all seen as a result of the pandemic may now be permanent. This business transformation will create many new revenue opportunities for new and emerging technology companies in the portfolios of many venture capital firms.
With fundraising at record levels, billions of dollars on the sidelines waiting to be invested and a favorable economic environment, VCs are under enormous pressure to put their capital to use on the next generation of firms. VCs are typically looking for fund internal rates of return (IRR) in the range of 25% - 35%. To achieve this level of performance, the fund will have to return approximately 8-10x its capital in a seven-year period. Considering that many investments may only return the capital invested or possibly even less, many of the portfolio investments in a fund will need to return 8-10x, to allow the fund to achieve its targeted IRR. This will continue to drive investment as VCs seek to diversify their capital across many portfolio companies. Fundraising is typically a difficult process for any VC, but it is absolutely made easier when a fund experiences top quartile performance.
Deploying Venture Capital in 2022 and Beyond
Today there is more money being invested by VCs than we have ever seen in history. With no shortage of capital to invest, VCs still need to be laser-focused on where they need to invest, including taking into account business changes brought about by COVID-19 and future variants. We expect VC firms to be laser-focused in certain areas.
The changes to our work environment accelerated a trend that was already well under way. Remote working, whether on a full- or part-time basis, will likely be part of our work culture on a more permanent level. This digital transformation will be supported by advancements in 5G technology, which will show dramatic improvements in reliability, bandwidth and data transfer. In addition, further enhancements to collaboration and communication software platforms will continue to drive productivity in a decentralized work environment.
Financial technology (fintech) enterprises are also getting their fair share of attention from VCs. About 20% of all VC dollars are being invested in fintech companies. Fintech continues to disrupt the traditional way we make payments, invest and obtain financing in an effort to make these much more efficient and transparent. VCs will likely continue to be focused on payment and financing platforms using cryptocurrencies and digital wallets to store those virtual currencies.
Cryptocurrencies have become the rage over the last couple of years. The significant appreciation of cryptocurrencies has made them increasingly attractive assets for returns and a possible hedge against inflation. The volatility of cryptocurrency is nowhere more evident than when one looks at the pricing of bitcoin. A bitcoin was worth $1,000 in early 2017 and today trades in the $60,000 range. With an approaching limit to the amount of bitcoin that can be mined, and more widespread adoption as a method of payment, expect continued interest from VCs in technologies and platforms facilitating the use of cryptocurrencies.
Health care and biotechnology companies have always been a focus of the VC industry. The impact of COVID-19 has made investments in medical and life sciences innovation increasingly critical. Also included in health care investments are digital assessment and analysis devices and other wearables that make remote doctor appointments that much more doable.
Advancements in artificial intelligence continue to be the direct result of significant investments of VC dollars in the space. Machine learning continues to advance adding to productivity and efficiency. The potential uses for artificial intelligence and machine learning are expanding every day.
The amount of renewable energy produced has increased since the beginning of the pandemic. The issues around climate change, global warming and the need for more renewable energy have led to increased levels of innovation and investment in the renewable energy sector.
In 2022, we are also likely to see more VC investment in areas such as gaming and content, innovative mobile technologies, smart cities, transportation and logistics and anything impacting ESG (environmental, social and governance).
It goes without saying that 2021 was a great year in terms of investments in the technology and life sciences industries. With innovation continuing at high levels and no shortage of capital to deploy, 2022 looks to be another solid year for the VC industry. There are some possible obstacles in the way, however, with continued supply chain shortages (most importantly computer chips), worker shortages, prospects of record-high inflation, possible changes in the Tax Code and possible interest rate hikes. As of the writing of this article, a new COVID-19 variant, Omicron, was discovered in South Africa and has also been seen in several other countries around the globe. This has created more uncertainly here in the U.S. as it relates to the pandemic situation.