Even as the venture capital industry shattered all records last year, it also continued to see significant changes to how it operates and its place in the startup ecosystem.
Last year saw seismic changes brought about by the likes of large hedge funds such as Tiger Global and Coatue pouring money into venture-backed startups and spiking valuations. It also saw some legacy players change the way they play the venture game, including Sequoia Capital’s plans to change its fund structure.
Some of those same trends will help shape venture in 2022, as well as the public market response to the pandemic and inflation, a growing reliance on data, and even a change in a VC’s workday, according to those in the industry.
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The biggest factor that likely will define venture in 2022 could be the public market. While 2021 was the biggest year to date for IPOs—with 399 offerings collectively raising $142.5 billion, according to IPO research firm Renaissance Capital—many of these tech stocks have been met with a lukewarm reception by public investors, even after some initial pops.
Even the first few weeks of the new year have not been kind as the Federal Reserve has signaled possible earlier rate hikes and other policy-tightening moves that typically negatively affect tech stocks.
Since the start of the year, the Nasdaq Composite is down nearly 6.5 percent—likely not the environment tech companies seek to go public.
How the market reacts likely could have a lot to do with how the seemingly never-ending pandemic plays out. Tusk said he sees the current COVID environment as a sort of “suspension of disbelief.”
If 2022 provides a road to more normalcy, valuations could come back to the real world, he said.
“You have seen private valuations not supported by the public market,” Tusk said. “VCs have one set of reality right now. Public investors have another set of reality.”
“The year could provide some choppiness with COVID, inflation and several geopolitical issues swirling about,” he said.
Valuations and big funds
If the market slows—and there is no guarantee that will happen—there is a question of how some of the larger firms that rapidly expanded their portfolios in recent years, like Tiger and Dragoneer, will react.
Tiger, for instance, made 350 deals last year according to Crunchbase data, but is known for being relatively hands off with its investments. That approach could make it easier to leave the tech startup ecosystem if a downturn occurs.
A lesser market also could cause large funds to move more slowly and cut valuations, although Sherman points out the model for these firms is to spend more and faster.
“They are commoditizing returns in the venture space by spending more and moving faster,” he said. “I’m not sure that would change.”
Competing in the market
That speed and pace continues to dramatically affect what used to be just the small cottage industry of venture capital.
With so much capital available and funding easier to get, some in venture predict another theme over the past few years that will continue in 2022 is that investors will need to make the value-add they bring to a potential portfolio company clearer than ever.
“I now spend about 20 percent of my week on the business development of (portfolio) companies,” Butler said. “People really want to know what value-add an investor brings.”
Tusk said investor value-add is one way some in the industry can compete against larger firms and funds. His firm focuses on regulated industries—a smaller area which helps weed out some investment competition and where it can show expertise.
“If you are in a niche … you can show you can provide value-add,” he said.
He added the changing dynamics of investors having to bring more to the table to compete could eventually make it difficult for more generalist and mid-sized funds.
“Those funds may find it hard to compete,” he said. “There’s just so much capital in venture now.”
More companies and data
That increased competition—and the proliferation of startups—also brought about another change many in the industry are talking more about this year—the use of data science in finding investment opportunities.
Just last year, there were 564 new fintech companies founded globally. The rate at which startups are founded is nearly impossible to keep up with and investors are turning more to data to help manage information on the flood of new companies and opportunities.
“It’s like there is a new company every day,” Butler said. “You need data sources to keep up.”
Investors are turning more to data science to keep up with the volume of companies—in a period where it’s nearly impossible to perform due diligence on every company in a given space.
“Five or 10 years from now (venture capital) will be 50 percent humans and 50 percent data science,” Sherman said. “If you are mid- to late-stage VC, there is a digital footprint now to monitor companies coming up through the ecosystem.
“Venture guys invest in this, and yet we didn’t start using it until five years ago,” Sherman said with a laugh.
Illustration: Dom Guzman
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