What's driving growth within the VC space?

Alex Di Santo, Crestbridge

By Alex Di Santo (pictured), group head of private equity at Crestbridge – It’s a good time to raise assets – which will more than double for the private equity and venture capital space by 2025.

Already the largest alternatives asset class, Preqin’s latest report shows that VC and PE combined will now represent more than half of all alternatives by 2025. This means the sector will more than double its assets from the current USD4.4 trillion at the end of 2020, to USD9.1 trillion by 2025.

Further, 80 per cent of investors surveyed intend to increase the number of their VC / PE manager relationships over the next four years – which indicates smaller managers can expect to benefit from this allocation shift too, not just the big names.

It’s a great environment for VC managers to deliver great returns – and investors know this

Venture capital and private equity funds have offered investors uncorrelated returns over the long term, a trend that is likely to continue to at least 2025 according to Preqin’s research. David Lowery, head of Research Insights at Preqin, said “our model shows that [venture capital and private equity] growth will continue... It’s a very exciting time to be a part of the industry.”

High earnings multiples assigned to deals is likely to continue throughout this period of easy monetary conditions, pushing potential returns higher. Low pressure on long term borrowing is also likely to stimulate new and even more sophisticated techniques to raising money, such as a wider use of subscription credit lines, where capital is invested prior to being called from investors, effectively leveraging returns.

The space is particularly compelling for investors especially when compared to other alternatives – for example, hedge funds are one of several asset classes expected to deliver less than 5 per cent over the same time period and will suffer net outflows by 2025 as a result. 

There will be more innovative start-ups and business disruptors emerging globally for VC fund managers to pick from

Greater returns in the VC and PE space is driven of course by a steady supply of start-up and disruptor companies. In 2020, 93 new unicorns were minted despite the pandemic, according to CB Insights, not far off the 120 or so that emerged in 2018 and 2019.

Such firms are expected to continue to emerge and flourish through to 2025, with industries like online grocery, healthcare, e-bike, gaming and EdTech expected to do well post-pandemic. 

According to Preqin, “[t]here appears to be no stopping private equity and venture capital” – a sentiment we can agree with.

Combined these factors pave the way for a meteoric increase in assets under management, but what are the overarching drivers behind these growing opportunities?

Covid-19 as an accelerator to pre-existing secular trends

Despite lockdowns across the world throughout 2020, the venture capital industry has been resilient, even counter-cyclical, to the macro environment. New fintechs thrived as lockdowns shifted the world's consumers online.

Schools, colleges and universities on lockdown propelled the edtech space. Healthtech shot forward several years, as a clear beneficiary of the continued, but recently very urgent, interest in health and wellbeing.

These and other beneficiaries of the pandemic were part of pre-existing, secular trends that Covid-19 has accelerated. In other words, companies in these sectors had tapped into existing consumer, health and work trends that were exacerbated by the pandemic. For example, data shows the healthtech space attracted USD10 billion of US and European VC investment over the first 9 months of 2020, with almost half going to providers of remote healthcare solutions.

With growing populations and the resultant strain on primary healthcare infrastructure, it is not difficult to see the use-case for virtual doctor appointments after the pandemic. It is more than likely that these companies are giving the world products and services that will be with us until long after the pandemic ends.

US and European VC investment in healthtech, by subsector (source: Silicon Valley Bank)

Crestbridge Chart 1

Venture capital continues to generate outsized returns for its investors

Globally, VC funds have provided outsized returns for their investors over the last decade and 2020 has been no exception. Venture capital managers returned 9.5 per cent in Q1 2020 and a reported 8.5 per cent in Q2, according to Pitchbook data. 

Crestbridge Chart 2

It is no wonder that this performance – widely sought after in the post-2008 world economy – has been rewarded by investors the world over with further allocations.

The maturity of the global VC space and the increasing importance of Europe

In Europe, consistent returns have contributed to the development of its burgeoning VC space, evidenced by a deeper pool of entrepreneurial talent and, more recently, the greater availability of investor capital. 

This has attracted investors from outside the continent, notably from US investors: according to Atomico’s annual survey, a third of all European tech fund investment originates from US institutional investors. It’s safe to say that many non-US deals involve US players, indicating the internationalisation, and perhaps the maturity, of an industry that was predominantly located in the Bay Area.

More generally, investors are clearly expecting more from Europe and they won’t have been disappointed by recent performance. Europe has managed to mint more unicorns through the pandemic, bringing the total number up to 60. By way of comparison, there are almost 200 unicorns across Asia and 137 in the USA, the most of any single country in the world.

Investment into European VC funds (source: Statista):

Crestbridge Chart 3

Another indication of a maturing industry is the higher valuations now given to European firms earlier in their development. Data from Atomico’s annual survey bears this out, showing the top quarter of European tech startups achieved early-stage valuations above GBP22million, a 38 per cent increase from 2019’s figures. 

Within the tech space, Europe has a good history of bringing these firms to IPO: there have been more tech IPOs in Europe than the USA, every year since 2016.

Success breeds success

Research shows that those venture capital managers who enjoy higher initial success see higher subsequent success. It's an intuitive finding: initial success may give managers preferential access to future deals and in turn, larger investors.

This affords those managers the opportunity to invest in higher quality assets that drive higher than average returns. Funds returning more than the average enjoy more investor attention, also commanding better terms with LPs.

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