VC Data is Bonkers. Now What?

There’s no shortage of money sloshing around today trying to find a home. That includes venture capital (VC). Financial headlines recently trumpeted very nice 12-month return numbers as of June 30 for brand name U.S. university endowments. Those results are largely due to VC valuations going “hockey stick” in the last year. We can’t add charts to this blog format but if you can imagine a chart that has the last 10 years on the x-axis and valuation $ on the y-axis, with a line plot from year-to-year that bounces a little but is fairly stable until 2019 at which point it jumps higher for 2020 and then jumps dramatically higher again in 2021, well then you understand what’s happened to valuations for VC deals.

BTW the email headline for the article with the hockey stick VC valuation chart was “VC valuations data is bonkers1 (emphasis is mine).

But wait! There’s more…the same publication recently shared a more detailed update about VC fundraising and exit data that included this heading2:

“These 6 charts show how much VC is awash in capital in 2021” (again, emphasis mine, as it is for the bolded words that follow).

With other great quotes:

Nobody wants to miss out on the great venture capital gravy train of the 21st century.”

“…this says much more about how fund allocators like pensions and endowments are flooding the VC market so overwhelmingly that venture capitalists are barely treading water trying to keep up.”

The gist of the article is that VC fundraising is about to top $100B in a single year for the first time; the value of deal activity is almost $240B this year (with 3 months to go; previous high: 2020 $166B); the fintech sector is leading the way; more “nontraditional VC investors” (hedge funds; corporate venture) are crowding into VC; and exit value is almost $600B this year (again, 3 months still to go; previous high 2020 $289B).

Yeah I’d say the data is a little bonkers. Yet the same is true for public stocks, high yield bonds, real estate…almost everywhere you look, you’ll find lots of capital, lots of competition, and very high valuations.

Capital is clearly not scarce in VC nor most other areas of the investing universe. But can we take the other side of that bet? If return on capital is likely to be higher when capital is scarce – which should be true, all else equal – is there a place where capital is scarce today?

“We were recently asked what it will take to get investors to switch from past market leadership to new market leadership. Our answer was momentum. For most investors, price action and not fundamental improvement defines an attractive investment. As we’ve repeatedly pointed out, the fundamentals already strongly support the shift in leadership from tech/innovation/disruption to cyclical/pro-inflation that appears to be underway. Investors generally have remained skeptical though, as they do at the beginning of most leadership shifts.”3

The quote above comes from a piece written in May 2021 by Richard Bernstein Advisors titled “Momentum investors will be buying energy and materials in a year.” I think they’re right.

Those two sectors are economically critical and yet are starved for capital today. Part of the reason for that is well founded – the economy must shift to sustainable methods for generating power and using materials ASAP. The companies we see as attractive today are the companies taking a leadership position in shifting these essential industries to ecologically sustainable low carbon/no carbon business models.

Businesses that are starved for capital but can lead decarbonization efforts in economically critical sectors. That’s the place where we’d like to see some momentum soon.