- Hedge funds and private equity are piling billions of dollars into late-stage, venture capital-backed tech startups amid a wider slowdown in the economy.
- Startups, particularly in financial services and software, have seen huge funding rounds led by hedge funds and private equity in 2020.
- Private funding rounds tend to be a cheaper entry point into fast-growing companies that are staying private for longer before they IPO.
- "The market is overheated but there are not a lot of places you can put your money," Niko Bonatsos, managing director at General Catalyst said.
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Big investors continue to pile into late-stage tech companies amid market turmoil induced by the pandemic, and low interest rates.
The Federal Reserve has indicated that the current low-rate environment could stay in place for as long as three years, leaving investors with little choice than to put money to work in financial markets.
Big investors are, once again, looking to tech to make a premium return.
"The market is overheated but there are not a lot of places you can put your money," Niko Bonatsos, managing director at General Catalyst said. "It's always competitive to win deals but the new vehicles we see are very aggressive, and it's easy for them to go back to the markets, [and] fill their coffers with money to invest given the availability of capital from SPACs."
Special purpose acquisition companies (SPACs) are a type of shell company that raises funds through an IPO that can then be used for acquisitions.
Sometimes referred to as a "blank-check company," they have gained popularity as private startups shun jittery stock markets, and have become vehicles for prominent names in private equity.
Non-traditional investors have participated in more than $50 billion in deal value so far in 2020, according to PitchBook's Q2 2020 NVCA Venture Monitor report. Private equity firms have invested in around 14% of all US venture capital deals, higher than in previous years.
According to the report, although bigger investors have piled into startups for some time, "the dearth of public offerings and the perceived opportunities to invest in distressed situations within VC" is an incentive to boost their exposure to venture further.
Recent examples include Coatue's deal with challenger bank Chime; Silver Lake's investment in payments startup Klarna; Attentive's $230 million Series D from Coatue, Tiger Global, and Wellington Management; and hedge fund D1 Capital Partners buying a stake in unicorn UK fintech TransferWise.
Similarly, stock trading app Robinhood closed two major rounds in 2020 as its valuation skyrocketed. The second of those rounds (a $200 million Series G) was led by D1 Capital Partners.
"I do think hedge funds have been more active because so much of the growth in our economy is happening in tech, and more of that tech appreciation happens pre-IPO, so if you're a public investor or hedge fund, you have to find the companies earlier," Jules Maltz, general partner at Silicon Valley growth stage fund IVP said.
There will be more of these deals in the future, given the low-interest-rate environment, according to Alex Ham, co-CEO at Numis Securities, which advised on the Klarna deal.
That's despite skyrocketing valuations, he added.
"Late-stage startups are experiencing accelerated adoption and growth rates, while incumbents are struggling," he said. "We haven't seen a global market event like this before and hedge funds are willing to move faster than many VCs in order to compete and deploy capital."
The market is used to mega-rounds after SoftBank
The market is, by now, pretty used to mega-deals after the advent of SoftBank's $100 billion Vision Fund in 2017 and the vast sums outlaid by Chinese investors in Silicon Valley until 2018, according to Anis Uzzaman, general partner and CEO at Pegasus Tech Ventures.
"VC-backed companies had issues initially from the Vision Fund because these companies were not simply not big enough for the check size SoftBank wanted to write, so valuations got raised," Uzzaman said. "It meant other funds had to follow the trend and that has gone on and on raising valuations across the ecosystem."
The trend is likely to continue, as investors look beyond traditional asset classes, companies hold off going public for longer, and pre-IPO rounds become increasingly competitive.
"Consumer habits have changed or accelerated due to COVID and with interest rates at zero, investors are willing to pay a higher multiple for growth companies," said Numis' Alex Ham.
"You take a five-to ten-year view on some of these companies, focused on a huge total addressable market, and you don't need to make heroic assumptions to see the market potential of these companies is enormous."
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