During the pandemic, investors hedged their risks by putting money into more mature technology start-ups, but the trend is expected to endure well beyond Covid-19.
The growing interest in later stage funding rounds that started last year as a hedging tool amid Covid-19 also comes as tech companies stay private longer and as so-called moonshot companies blow through capital. Companies developing self-driving cars, for example, require huge amounts of money for multiple years of research and development, according to a technology report from Bain & Company, the global management consulting firm.
The number of late-stage deals grew 165 percent from the first quarter of 2020 to the first quarter of 2021, according to Bain & Co.
“Investors have flocked toward surer bets to hedge risk and ride out the storm. But we expect this preference for later-stage rounds to continue after the pandemic,” co-authors of the VC section of the report Michael Schallehn and Chris Johnson wrote. “Venture-backed companies are choosing to stay private longer, which allows them to continue investing in revenue growth by avoiding capital market pressure to focus on profitability.”
In the first quarter of 2021, 70 percent of total venture investments were in tech startups. That came after a decline of 13 percent in tech between 2018 and 2020 — the first decrease since 2012.
But venture capital investors and corporations also must grapple with new headwinds from all the newfound popularity in the form of competition, risk, and rising deal prices.
Recently, VC investors have shown the greatest interest in artificial intelligence and cloud technology. Together, the two sectors make up over one-third of all tech VC investments. In AI, VC investors gravitated toward startups with products that solve hyper-specific problems in particular industries, such as transportation and healthcare. The majority of AI deals occur in the U.S. and China, a dynamic that has given rise to “the formation of two competing ecosystems around this strategically important technology,” the report said. With cloud technology, investors are looking to companies with a “horizontal or cross-industry” focus.
For investors, these VC conditions present a double-edged sword: The landscape is ripe with both ample opportunities and risk. “There’s no shortage of opportunities to invest, but increasing competition and rising deal prices increase the odds of missteps,” the report said.
Bain & Co. authors have a few suggestions for corporate investors hoping to get into the tech space. First, an investor should become a partner or customer, authors wrote. Instead of blindly investing in a company, top VC investors often first consume its products or services.
“This is one area where corporate investors can gain an edge against traditional VC firms, which don’t always have a clear use for their portfolio companies’ products,” the report said.
Second, investors should be direct about the nature of the relationship between investor and start-up. This tactic includes establishing a “deal thesis,” a plan that contextualizes the investment and makes clear to the start-up the advantages of receiving capital from a corporate VC.
Lastly, the authors suggest corporate investors build a targeted portfolio, which entails making investments in several, well-researched companies that align with the firm’s original strategy.