For tech startups, it’s no mystery that 2021 has been a strong environment to raise startup funding. Investors are in abundance and willing to invest larger amounts than ever. In fact, tech startup financing hit a record of $150 billion in the first half of 2021. That’s more than the amount of full-year funding for every year before 2020.
Part of the increase in overall funding is due to the influx of funding from big money management firms. Non-traditional venture capital investors are in, too. These include hedge funds, mutual funds, pensions, sovereign-wealth funds, and other large institutional investors.
Financing of Tech Startups from Nontraditional Investors
In the second quarter of 2021, 42% of financing for tech startups came from these large, non-traditional venture investors. Out of the top ten investors in startups, around half are non-traditional investors. Tiger Global Management is a New York-based hedge fund and investment firm. It has been a particularly active investor in Internet, software, consumer, and financial technology startups. Fidelity Investments, a financial services company established in 1946, is one of the largest asset managers in the world. It has also been actively investing in internet and financial technology startups, especially cryptocurrency companies.
“I have to be flexible and give much more than I used to,” stated Andy Boyd, an executive at Fidelity. Mr. Boyd played an instrumental role in helping Fidelity branch out into investing in tech startups.
Large Pools of Capital
Institutional investors have large pools of capital to deploy. Moreover, they are often are less interested in obtaining board seats than venture capitalists. Institutional investors sometimes settle for getting observer seats on the board of directors of tech startups. Observer seats lack voting rights. This contrasts with getting an actual board seat, which comes with full voting rights. Observer seats are seen as beneficial from the standpoint of a growing tech startup and its founders. The ability to obtain large sums of startup financing while maintaining control over decision-making is seen as an appealing combination. Data reveals that non-traditional investors also tend to have lower return thresholds than their traditional venture capital counterparts.
The Motif FoodWorks Example
Motif FoodWorks Inc., a producer of plant-based meat substitutes based in Boston, recounts the contrasting perspectives between large money managers and traditional venture capital firms in its recent fundraising experience. Motif FoodWorks Inc. recently raised a $226 million Series B funding round led by the Ontario Teachers’ Pension Plan and Blackrock. CEO Jonathan McIntyre noted that traditional venture capitalists had balked at the huge valuation of his 2-year-old startup and the idea of only getting observer seats on the board of directors.
Another Tech Startup: Beta Technologies
Beta Technologies Inc., an electric aircraft startup, was able to obtain more flexible deal terms and substantial amount of financing for its 4-year-old startup in a round led by institutional investors. It recently raised $400 million in a round led by Fidelity Management. A unique deal term granted to Beta Technologies by Fidelity Management was the right for more than 70 Beta Technologies employees to invest in the round and receive shares at the same discounted price as Fidelity. Beta Technologies had also pitched to venture capital investors, but they balked at the company’s high valuation and the requested deal terms.
The Federal Reserve is Doing its Part
The near-zero interest rate environment has propelled some of the momentum. The Federal Reserve is expected maintain near-zero interest rates until at least 2023. Additionally, the IPO market has remained strong in 2021 and there has been a high volume of deals involving the sale of startups to larger companies.
The strong financing environment for tech startups has given startup founders more negotiating leverage. Some startups are showing up to investor meetings without pitch decks, long considered a standard necessity for meeting with venture capital firms. Some startups also feel able to ask investors for extra benefits. For instance, some startups will ask investors to connect them with potential customers. Many startup founders are asking investors for equity refreshers, which prevent dilution of the founders’ dilution ownership stake in the company.
In order to keep up with non-traditional investors, venture capitalists are deviating from their standard practices. “There are no VC funds with pricing discipline. All of us have caved,” stated Keith Rabois, a well-known tech investor and general partner at Founders Fund.
To put the numbers into perspective, between 2016 and 2019 there were an average of 35 deals per month that had funding rounds in excess of $100 million. In 2021, there have been an average of 126 deals per month raising more than $100 million in financing.
Startup valuations have been hitting eye-popping numbers as a result. It is more common now to see unicorn startups, or those that have attained valuations of at least $1 billion. In fact, between April and June 2021, 136 companies achieved unicorn status. Looking back at the same April-through-June quarter five years ago, only 14 companies had valuations above $1 billion.