Venture capital activity: a blowout Q1 2021 and what might be to come

Jeff Grabow, EY US Venture Capital Leader, gives his thoughts on the Q1 2021 venture capital landscape and expectations of what’s to come.

In brief

• Companies raised capital to sustain and preserve in case of a prolonged downturn.
• We saw record mega-round activity and technology was seen as a solution and problem solver.

It seems hard to believe that just one year ago we were concerned about how venture capital (VC) and investment activity would continue in the wake of the pandemic and the work-from-home mandates. Now, after witnessing a record-breaking first quarter that guarantees a fourth successive $100 billion year, the question we’re asking is whether we’ll surpass $200 billion in 2021. 

This truly was an unprecedented quarter. Equity financing for US VC-backed companies topped $64 billion in Q1 2021, smashing the old record of $51 billion set in Q4 2018. In fact, the total amount raised last quarter surpassed VC activity for all of 2013. Mega-round ($100 million and over) investments accounted for more than 60% of activity, with 183 deals raising $39 billion last quarter.

A number of factors converged to turn this into a blowout quarter: 

• There remains a significant number of companies that are still scaling and need to raise capital, as evidenced by the strong mega-round performance. 
• We are seeing a number of new opportunities surface as technology is pushed into industries that haven’t leveraged it in the past. Many of these promising developments will continue to attract capital.
• Finally, macroeconomic conditions, including the strong capital market rebound, IPO and special purpose acquisition company (SPAC) activity, vaccine rollout and declining unemployment rates, have been favorable. The sense that we are emerging from the pandemic leads to a more optimistic outlook that gives an additional lift to companies needing to raise capital, especially in areas where technology has a much bigger impact. I am anticipating a strong economic rebound that will be very beneficial to VCs.

Technology leads the way for venture capital

Software

The ongoing push for new technology and software to support digital transformation helped this sector report a record quarter at $15 billion raised. The pandemic’s impact on many businesses accelerated the digital future. Companies that are making smart investments in technology have positioned themselves to reap the benefits and grow through and beyond the recovery.  

Biopharmaceuticals 

Biopharma came in as the second-leading sector, reporting $11 billion in Q1 and exceeding the full year’s activity for 2016. Advances in this sector were accelerated by the pandemic, and lessons learned will help in developing solutions to cure numerous diseases. Companies working to meet the ongoing needs of an aging population with novel solutions will continue to draw investor attention. 

Financial services

This third-leading sector reported significant new activity, particularly in financial institutions and services, and saw 144% growth quarter over quarter in dollars invested. This was led by investments in areas that enabled consumers to purchase stocks, make payments and gain access to financial systems that weren’t possible before. 

Regional activity in venture capital

San Francisco continued to lead regionally, with New York and Boston coming in second and third as in prior quarters. Atlanta also cracked the top 10 regions for VC activity, fueled in large part by new unicorns.

We have heard some noise around the flight from the Bay Area and other traditional VC hotbeds, but we haven’t seen this impact the level of investment yet. I believe we will see additional disbursement of capital to other regions; however, it will take time.  

Explosion of mega-round activity

Megadeals were out in force last quarter, playing a major role in driving investment results. The top 15 national deals were all $500 million or more.

In addition to mega-rounds, we saw record investment in series A, B and late-stage rounds: 

• Series A funding totaled $7 billion in activity, which bodes well for the future as it signals increased new company formation and support of emerging ideas and markets.
• Series B reached $11 billion, up 63% from what we saw in this same quarter in 2020. The biopharmaceutical sector was particularly strong. 
• Late-stage venture funding also rose to $32 billion, up 104% quarter over quarter. We are also seeing strong fundraising activity as companies move through the venture pipeline and prepare to scale.

What’s next for venture capital

We fully anticipate that the VC market will continue to run hot as technology and innovation continue to fuel growth in the asset class. At this point, it’s difficult to imagine what could hinder investment activity in the near term. However, one factor to watch is the market slowing under the sheer volume we’ve seen since 2018. As a reminder, in each of the past three years in the US, more than $100 billion has been invested in venture-backed startups, with two of those years setting records. We are now on pace to set another record. 

Three factors are driving our optimistic outlook: 

1. Fund formation: All future signs point to strong fund formation as low interest rates will continue to attract more investors seeking yields. This has been evidenced by a record 2020 VC fundraising year at $80 billion, followed by record Q1 2021 fundraising at $33 billion.¹
2. Capital deployment: We have a record number of operational venture-backed startups that will continue to raise capital. We expect a prolonged period of investment as businesses become more technology enabled. This will allow investors to continue to deploy vast amounts of capital.
3. Liquidity: A number of unicorns have gone public in recent months, fulfilling the promise of venture investment returns. We are also seeing an explosion of SPACs that are providing an alternative path to the public markets. In addition, direct listings are evolving to allow more optionality to raise new capital. 

My crystal ball is as cloudy as anyone else’s. Still, I am optimistic. This will be a period of great innovation. I’m confident we will see some truly transformational companies emerge that we should all be keeping a sharp eye out for.

The views expressed by the author are not necessarily those of Ernst & Young LLP or other members of the global EY organization.

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