By Sherman Williams
Venture capital (VC) is fundamentally about investing in future innovation. There can be several catalysts that fuel this innovation. Still, I believe it is most important to consider a company’s ability to change consumer behavior, whether the consumer is an individual or a business. In 2020, COVID-19 significantly changed consumer behavior and served as a catalyst, driving VC investment to greater than $150B invested — a 13% increase over 2019 and higher than it has ever been.
Greater than 80% of VC funding goes to software-based startups, and these companies benefited from the inability of people to meet in person due to COVID-19. The migration of transactions and general work to a virtual environment has been steadily occurring over the years, and COVID has accelerated these trends. I believe there will be some mean reversion once we are past this crisis and can meet again (please let that happen soon, but there will be long-lasting effects). Said another way, consumer behavior will forever be changed. Now that the numbers are in, the following article summarizes VC’s state in 2020 with my opinions (in italics) about what occurred and the future impact. 
The year 2020 was the best year ever for the VC industry from a capital deployed and, most importantly, from an exits perspective. Firms deployed $156B, and most importantly, the industry saw $290B in exits.
The majority of this funding went to a small group of companies, and many of them were later stage (raising greater than Series C) companies. A record 321 mega-VC deals closed in 2020, up 33% from 2019. Of these mega-deals, 265 or 83% were later-stage deals. Late-stage deals accounted for 66.7% of the total deal value in 2020.
Opinion: A small group of later-stage deals accounting for the majority of VC-capital invested has been a trend for several years now and it is one that will likely continue. Reasons include i) companies find being public an arduous process and are taking longer to go public ii) the secondary market for the private shares of VC-backed companies is robust and growing, and iii) more capital that is seeking alpha is entering into the Growth Equity market from Private Equity firms and large Asset Managers that are doing direct deals. I believe the VC market is benefitting significantly from low-interest rates making the cost of capital cheaper, and VC is becoming an in-vogue alternative market. Low-interest rates are resulting in reduced yields for fixed income securities making them less attractive. Also, VC is becoming a more attractive market when one considers the risks being taken relative to the recent extreme volatility of the public markets.
While the later stage landscape saw robust activity, the early-stage venture capital ecosystem experienced a slight decline in the number of deals, with the amount invested flat 2019 vs. 2020. An interesting observation is that median and average deal valuation investment sizes actually increased, meaning that investors at the earliest stages sought to own a more significant share of the companies they invested in.
Opinion: The number of deals and the amount invested was down, but I do not expect this trend to continue. At the pre-Seed and Seed stage, where AIN invests, the number of deals and capital invested will increase in 2021 and beyond.
Opinion: Seed deal sizes increased in 2020, which is a fact, not an opinion. But seed-stage deals have been trending higher for years, and what is my opinion is that I believe this year was more pronounced due to companies wanting enough capital to weather potential economic storms. Additionally, investors required a greater share of the company they were investing in to improve their return profile.
It is important to note that healthcare accounted for a disproportionate number of deals in 2020, both from many deals and deal value standpoints. Over half (14 of 25) of the largest early-stage deals (deals where the company raised $25M or greater despite being young) were in healthcare. Healthcare accounted for more early-stage deal value and volume than at any time in the last ten years.
Opinion: The increase in healthcare deals is one that will last, albeit the steepness of the increase will level off as effects from COVID-19 subsides. There has been a revolution occurring in healthcare in many different industries from precision medicine (fueled by next-generation sequencing), to genetic medicines (gene therapy and gene editing), telemedicine, and finally advancements in connected devices that enable predictive analytics to prevent health issues as early as possible. I believe these technologies are in the early stages of development and a great deal of growth will occur for many years to come. Evidence of this is the fact that 0.1% of all healthcare visits were telemedicine visits prior to the pandemic, but that percentage increased to 14% at the height of the pandemic in 2020. I believe this 14% penetration is low and there is tremendous room for growth as technology offerings improve.
One of the essential occurrences within the VC ecosystem in 2020 was the increase in deal exit value. From IPOs to SPACs, direct listings, and M&A, VC investors experienced record-setting liquidity in 2020, even though the actual number of deals exiting actually decreased.
Opinion: The direct listing trends will continue, but the SPAC trend will eventually decline because I believe many companies that are not ready for public market scrutiny have been going public via SPAC. Sub-optimal performance from these companies will eventually negatively impact the SPAC market. The SPAC market requires patient capital, investors who are willing for the company to develop while operating as a public entity over 5-10 years. In the near future, I will publish a note regarding my thoughts on the SPAC market, to keep it short, I have mixed feelings, and SPAC activity should be considered its own asset class with unique pros and cons.
Geographical distribution of VC: Historically, the investment of VC capital has been heavily concentrated in three states, with California, New York, and Massachusetts accounting for ~80% of all funding distributed in 2019. California has always been the industry leader, dominated by the San Francisco-San Jose-Oakland (Bay Area) metro region. Boston was in second place for many years, but New York City definitively surpassed it in the last decade, and Los Angeles has now surpassed it.
COVID-19’s impact on the importance of geographic location and fundraising was not as pronounced as media reports may suggest, according to the data. Overall, founders were not significantly impacted by fundraising moving online, but as we mentioned, the number of deals was down in the earliest stages, and the amount of capital raised at the early stages was flat. I believe the trend would have been better had the world been in a different economic environment. Additionally, the number of deals was down in every geography, except Boston and Atlanta. I do not have an answer for the Atlanta trend, but Boston being up is likely due to the concentration of life science and digital health companies in the region. The media reported that Austin is increasingly a recipient of VC capital, but the number of deals there decreased in 2020, likely due to the preponderance of deals at the earliest stages. Additionally, total deal value was actually down in Austin, unlike other similar-sized but second-tier VC areas like Chicago, Minneapolis, and Denver.
Another data point is where new VC capital was raised in 2020. VC firms raised a record $73.6B across 321 funds, shattering 2018’s record of $68.1B raised.
Despite the record year of fundraising, most capital raised was still in the critical capital tech hubs in California, New York, and Massachusetts. This trend supports my conclusion that for the next ten years at least, and I am facetious here – it will likely be longer, the kind of innovation that VC fuels will remain located in these areas.
Opinion: While some capital may migrate outside the vital tech hubs, which I believe is a good thing, by the way, it is imperative to have linkages to the California, New York, and Massachusetts tech and VC ecosystems. VC capital ties closely to the intersection of innovation centers in the U.S. (strong academic institutions, research labs, etc.) and private capital. For example, while certain tech titans may depart the Bay Area, Stanford, UC Berkeley, and NASA are not leaving. The aforementioned top three regions will continue to outperform relative to the rest of the U.S. While I believe some talent will migrate away, significant change will not occur until U.S. government research dollars also migrate to other areas. I have no indication of that happening anytime soon, and post-COVID, I believe research dollars will continue to flow to California, New York, and Massachusetts. This said, and I am non-biased since I currently sit in NYC, if one considers the cost of living, particularly compared to NYC and San Francisco, the weather, a robust university system, and strong defense ties, I believe Los Angeles will be one of the biggest benefactors of the post-COVID environment. We purposefully built AIN to link to these areas while making fundraising a virtual experience for founders and AIN members.
Conclusion: The year 2020 was quite interesting due to COVID-19. The VC ecosystem was not spared from the pandemic’s effects. Considering the preponderance of VC companies operate in the virtual world, COVID-19 was uniquely helpful to the VC space. Trends that were not expected to take effect for five to seven years accelerated over three quarters instead. The longer it takes for mass vaccinations to occur, the more economic activity will move to the virtual world, and the more consumer behavior will be conditioned to interact primarily in the said world. To invest in VC backed startups is to invest in the future. While today things may seem bleak, I would argue the future is bright. Invest in the future alongside fellow Academy Grads (AIN Syndicate Member Signup).
This article was written by AIN Managing Director Sherman Williams. If you have additional questions, please contact Sherman Williams (Sherman@academyinvestor.com).
 https://pitchbook.com/news/reports/q4-2020-pitchbook-nvca-venture-monitorRock Health 2020 Digital Health Report
 Rock Health 2020 Digital Health Report
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