Venture Capital’s Exit Market Boom Could Be Hit by Hot Deal Market

Investors hoping to further capitalize on the post-COVID economic recovery in North America have accelerated deal value sharply 

Last year a dramatic rise in venture capital-backed exit values fueled the best performing calendar year ever for the broader venture capital (VC) market. The success of VC managers during H2 2020 no doubt drove investor demand to keep the good times rolling. Exit activity may still be far above historical norms, but it’s cooling off, and meanwhile deal values have escalated sharply, which could catch up with and temper hopes of future outperformance. 

During a COVID-19-plagued 2020, average US and Canadian exit value rose 66% from $338mn to $560mn. The year saw $246bn in aggregate exit valuations on more than 1,000 individual transactions – astoundingly high for the market (Fig. 1). A combination of factors, such as low discount rates, high public market equivalent valuations, and competition, all played a role in this run up. And these trends bled into the new year. Through the first eight months of 2021, North American venture capital funds have exited 780 positions for a combined $238bn. While exits are on pace to surpass 2020’s highs – which drove a 37.2% annual return according to the PrEQIn Venture Capital Index – it’s not certain they can be maintained as entry valuations rise (Fig. 2). 

Meanwhile, VC deal values are on the rise again in 2021. Investors are looking to capitalize on innovation, progress, and perhaps the residual effects of the broader post-COVID economic recovery in North America. Deal valuations (essentially the cost of admission) have begun to catch up with exits for many VCs.

Recorded deal totals are usually higher than exit totals. This is in part due to the increase in capital coming into the segment allowing funds to make larger investments, and in part because recording exit values is much harder than entry values, particularly where investment performance has not been strong. Having recorded aggregate exit values in excess of deal values is rare, occurring only twice in the past decade, with each occasion driving with a spike in returns.

The combined value of capital handed out by GPs in 2021 was $284bn by early September, almost $100bn more than for 2020 as a whole. Through the first eight months of 2021, the average deal size was about $70mn, up from $34mn in 2020. Still, fewer deals have been made so far this year, about 4,600 to date compared with 7,000 last year. But the pace of investment is not slowing down.

Tech and healthcare companies have gained the lion’s share of this haul. Combined, the two industries have collected $221bn in capital from VCs so far this year, already up from last year’s $156bn. The industry has also been a key driver in the rise of the average individual deal; tech founders are seeing an average $83mn in capital investments, up from $34mn last year. Healthcare companies, still number two among the broader industry categories, have already amassed $52mn to almost exceed the $62mn raised in 2020.

It’s difficult to see VCs’ influence on private markets wane in the short- to mid-term. VCs will keep turning every rock looking for the next big thing and, with the pace of technological change increasing, there are more next big things than ever before. But, as more investors put money into VC strategies, some managers under pressure to deploy capital may find it difficult to exercise restraint. There are not many individuals still actively making investments today that were around through the dot-com boom and bust, but in this instance the period serves as a warning from history. Rolling one-year IRRs from VC investments climbed through the late 1990s to peak at 56.7% in 2000, before plummeting to a loss of 39.5% in 2001. It wasn’t until 2004 that VC funds were back in positive territory.