Seed investment took a hit during the Covid 19 pandemic, with business angels and venture capital funds (VCs) electing to put more of their capital into late-stage startups such as unicorns with valuations over $1 billion, according to Crunchbase.
But this strategy, which was generally perceived as lower risk in the teeth of the pandemic, is showing its limitations as the global economy emerges from lockdown. All ambitious business angels are looking for a ‘fund-maker’ business that makes enough money to return their entire portfolio. But normally that can only happen by investing money at the beginning of a startup’s life, where a greater share of equity can be acquired at a lower valuation.
There was a widespread reluctance to invest seed money during the market turmoil of the past 12 months. Global seed-stage funding dipped from $3.9 billion to $3.5 billion in the second quarter of 2020. Now funds are sitting on substantial amounts of committed but unallocated capital. This ‘dry powder’ store of capital that has not yet been spent is under pressure to generate a return, especially as the historically low-interest rates of today are unlikely to rise significantly in the near future.
This suggests that competitive tension among investors is going to rise this year. Young veterans from established tech companies like Airbnb are now launching startups of their own, bringing sophisticated products and a market-savvy approach to fundraising that puts them in a strong position. As the overall quality and ambitions of startups rise, so do valuations and the size of seed rounds. Despite the pandemic, €41 billion was spent on technology startups in Europe in 2020, according to research by Atomico.
Overall then, the balance of power is shifting in favour of startups. Gone are the days when Tesla got the cold shoulder from companies like BMW when they wanted to explore tech sharing. Now it’s startups like electric truck specialist Hercules that can decide whether they want to take a call from Nissan.
Optimism about today's investment landscape is partly possible because early-stage investment faced considerable headwinds in 2020. Investors found that performing due diligence was hampered by lockdowns. But widespread adoption of digital tools has allowed business angels to perform the kinds of human-focused mentoring and supervision that are one of their strong points, especially when data on market traction is scarce. In most cases, these tools have enhanced and streamlined the due diligence process.
As vaccination campaigns proceed, it is reasonable to believe that due diligence will get easier for early-stage investors.
Values and valuations
Seed stage investment is an area where angel investors can successfully compete with big portfolio, multi-stage investment houses. A business angel who shares a founder’s values and connects with issues that affect the startup is naturally in a better position to identify hidden growth potential and strike an advantageous deal than a relatively faceless institutional investor that relies on more formal assessment criteria.
Seed and pre-seed investing do require high levels of engagement and mentoring, but the potential rewards are disproportionately high. Pitchdrive takes care of this essential groundwork in order to free up time for its busy business angels. But what kinds of startups are business angels looking for, and what factors are guiding the flow of capital right now?
A sustained shift from offline to online digital infrastructure, often referred to as the cloud, is perhaps the single most important long-term factor directing investment flows in technology startups. In fact, this quiet but profound change underpins most of the noisier trends that are likely to grab the headlines as the year unfolds. Artificial intelligence (AI) is, of course, the other big development of the past few years. Its transformative potential still has a long way to go and is set to absorb many more billions of dollars of investment across multiple sectors.
AI is driving many of the advances in life sciences, cybersecurity and fintech where startup valuations are on a steep upward trajectory. The fourth quarter of 2020 saw revenue multiples of 15x in fintech. According to CB Insights the first quarter of 2021 was the largest on record. 614 VC-funded deals raised $22.8 billion in total, which is a 98% rise year on year.
AI is also driving renewed interest in climate tech and biotech. These are capital-intensive sectors where AI is being deployed to reduce the notoriously long development timelines that have deterred investors in the past. Specialised funds now work closely with universities and other research institutions to accelerate therapy development and get them to market at scale.
The rapid development of successful new vaccines based on AI-enabled science demonstrates what new technologies and agile processes can achieve when there is ample funding and enormous price-insensitive demand in the marketplace. Governments have played a key role in facilitating both supply and demand for vaccines. Indeed, large-scale state intervention in pharma could be here to stay. Whether this will crowd out or encourage private investors over the next 12 months remains to be seen.
Consideration for biodiversity, climate change and societal inequalities is another feature of the new investment landscape. Green issues are close to the heart of many business angels, and play a part in guiding their investment decisions. There is even a willingness among institutional investors to weigh up longer-term systemic risks that threaten the smooth running of global capitalism.
A more important driver is the market. Consumers increasingly demand products and services that have sustainability and some form of societal mission at their core, and are willing to pay a premium for them. More than one third of consumers reported that they are knowingly paying more for green products since the pandemic, according to a recent UK survey conducted by Circular. This has given rise to so-called impact technologies, which look set to be a standout trend in the 2021 investing landscape. The pandemic has also put digital collaboration tools and distributed work startups firmly on the map, and this trend has further to run.
A renewed appetite for seed-stage investment and a willingness to embrace longer-term exit strategies are likely to be features of the 2021 investment landscape. Investors are deciding to take a larger risk earlier on in the life of a startup in order to reap exponential gains further down the line, especially where AI is in the mix.