When the coronavirus pandemic struck the economy last year, investors braced for significant fallout in almost all asset classes.
Between the middle of February and late March of 2020, the S&P 500 Index dropped nearly 32% as the equities market took a beating. Investors in commercial real estate thought market values might plummet and loans would go into default given that much of the world had to stay home to avoid contracting the virus. And broad swaths of the economy shuttered for weeks and months at a time, as states and other governments imposed stay-at-home orders and lockdowns.
Venture capital did not escape the chaos as startup investors sought to shore up their own portfolios by focusing on their existing portfolio companies in an attempt to steer them through the hardship.
But the coronavirus pandemic, while extremely scary in the beginning and still not resolved, proved to be an extraordinarily transformative event for the entire VC industry. It changed how VCs operate, how technology is used, startup creation, and overall investment activity. Let’s take a look back at the wild journey the industry has been on since the pandemic started.
One of the worst parts about the pandemic for investors everywhere was simply the sheer uncertainty of it all. Nobody knew how long lockdowns would last or how quickly an effective vaccine(s) could be distributed. That meant a slowdown in new investment activity during the first few months of the pandemic, April through June.
In April of 2020, U.S. VC deal activity slowed to 600 deals worth $7.3 billion, down from 867 deals worth more than $13.7 billion in March of 2019, according to Pitchbook. For the second quarter of 2020, total deals and deal value fell to 2,197 deals worth $34.3 billion, down from 3,102 deals worth $36 billion in the second quarter of 2019.
But one could argue that this didn’t really paint the full picture of the decline because while total deal volume hung in there more or less, the dynamic and scope of VC funding shifted away from new investments.
First-time investment deal volume in the second quarter was $1.7 billion, down nearly 59% from the second quarter of 2019. Meanwhile, follow-on VC investment deal volume rose 2.5% year over year.
It makes sense to a certain degree, as most VCs were spending more time than usual with their current portfolio companies and likely assessing what they needed to keep going.
“We had a lot of meetings about PPP (Paycheck Protection Program) loans, layoffs, cash, and how to shift and continue to do work when the (contract research organizations) in China were shut down, and people were not in labs and it wasn’t clear who was an essential worker,” Julie Grant, a general partner at the early-stage VC firm Canaan Partners, told MedCity News last July.
VCs invest in businesses of the future, typically through technology that might be years ahead of its time. The idea is that you invest in future trends way ahead of everyone else so when the general population starts to adopt these trends, the company is well positioned and has a first-mover advantage.
But for all the preaching, VCs were operating under a somewhat old-fashioned model that involved meeting with portfolio companies face to face. This, again, makes a certain amount of sense because a lot of VCs are really investing less in an idea, and more in the founder that is pledging to bring that idea to fruition.
VCs want to be up close; they want to get a sense of how that founder is doing; how they are managing the stress; how excited they are about their progress, how confident they feel, etc.
But the pandemic really changed this dynamic because people were working remotely and didn’t want to travel in order to avoid contracting the virus.
This in turn forced investors to turn to video-conferencing technology like Zoom, technology that many VCs had invested in but didn’t use themselves for deal making. You could see this trend play out on Silicon Valley Bank’s earnings call in October. Silicon Valley Bank does a lot of lending to VC and private equity companies, so they have a pretty good pulse on the industry. Here is Silicon Valley Bank CEO Greg Becker on how the Zoom trend picked up in VC deal making:
When the pandemic first hit, I was on a number of Zoom calls with venture capitalists and the first call, which was probably three weeks into, two weeks into the COVID crisis, there were 20 venture capitalists on the Zoom call and there was one that was considering doing it. We had one a few weeks ago and everyone was doing it. Everyone was doing it and they were just talking about how efficient it was and how this is maybe a new normal and will allow them to look at investments more broadly in different markets where it's easier to kind of connect with those founders, the executive team of those companies. And the same, obviously, is holding true in private equity as well a little bit slower. But as we said in the note, it is definitely picking up. So there's no question that deals are being done over Zoom and I actually think that they're feeling really good about it.
While the beginning of the pandemic may have presented an extremely difficult challenge for VCs, the agile group has had no trouble adapting.
By the time 2020 ended, VC-backed companies had raised a record $130 billion, a number up 14% from 2019.
However, new investment activity continued to lag. The number of total deals declined 9% in 2020 and the number of mega-deals -- those $100 million and higher -- also touched a record with $63 billion raised in less than 320 deals.
“What we’re seeing is a ‘rich get richer’ phenomenon where successful, high momentum technology companies are vacuuming up most of the financing,” CB Insights CEO Anand Sanwal told Reuters earlier this year.
This trend may be a result of what we touched on before, with investors being more cautious and only investing in companies they have 110% confidence in, or are already invested in. But this will be an interesting trend to watch play out this year.
That said, I don’t think there is any doubt that the VC industry is better positioned than it ever has been. From the most recent data available in September of 2020, global VC dry powder is at an all-time high with $278 billion ready to be deployed. (https://s26.q4cdn.com/898615280/files/doc_financials/2021/q1/v2/Q1_2021_IR-Presentation_FINAL3.pdf, slide 7)
And in the months since the pandemic began, the use of technology has greatly accelerated. Digital payments and delivery services powered by apps are more integrated into our life than ever before. Consider this: Visa, one of the largest payments companies in the world, announced that 13 million cardholders in Latin America and the Caribbean made their first ever online purchases in the first quarter of 2020. Think about where that number might be now.
Recessions tend to birth a lot of entrepreneurs because when unemployment rises, more people are forced to go out on their own. Additionally, the heavier use of technology will prompt more startup creation.
Following the Great Recession, companies like Uber and Airbnb were founded and fundamentally changed the economy. There is a good chance that we could be in for another round of game-changing companies once things fully normalize.
“The attention that's being given to the broad innovation economy, both domestically and globally, has never been this high,” Becker said on Silicon Valley Bank’s most recent earnings call. “And while it may be volatile, I'm certainly betting -- we're betting on it continuing to go up and to the right over the long run.”