Hedge Funds, Private Equity, and Mutual Funds Drive Venture Capital Activity to New Highs

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It’s been a record-breaking year by all measures for the venture capital industry.

Venture capital firms in the U.S. raised $238.7 billion through the first three quarters, beating by a wide margin the annual record of $166.4 billion in 2020, according to a PitchBook report released Thursday. 

The contribution of venture-backed companies to the public markets is even more striking. Overall, the value of company exits year-to-date reached $582.5 billion, more than twice the size of last year’s record of $289 billion. Initial public offerings accounted for 88 percent of the total exit value, with mega-deals exceeding $100 million.

Nontraditional investors like private equity firms, hedge funds, mutual funds, and others are increasingly interested in the venture capital world. PitchBook estimated that nontraditional investors will participate in deals worth $183.6 billion in 2021, up from $126.3 billion last year. 

One factor that’s driving up venture capital deal value is that companies are staying private longer. As a result, investors have multiple opportunities to invest and start-ups can grow quite large before entering the public market, according to Kyle Stanford, senior analyst at PitchBook.

The lure of venture capital to crossover investors is not surprising, according to PitchBook. 

“In theory, if hedge funds and mutual funds wait until those companies go public, they are missing out on that huge valuation growth while the company is still private,” Stanford said. His team has done research showing that nontraditional investors earn twice as much on average when they put money into pre-IPO deals, compared to when they purchase shares after a company has gone public. 

Private equity, hedge funds, and other nontraditional investors are particularly interested in late-stage financing rounds and mega-deals, according to the PitchBook report. They were involved in half of the late-stage deals — totaling $150 billion during the first three quarters — compared to 33.5 percent of early-stage deals. About half of all mega-deal transactions in 2021 are solely backed by nontraditional investors.

Hedge funds, which have liquidity restrictions, often invest in late-stage deals to make sure their capital isn’t tied up for a long period of time. Others simply don’t have the capacity to vet early-stage start-ups. 

Nontraditional investors also are often “less price-sensitive” and “offer less stringent deal terms,” than others, giving them an advantage, according to PitchBook. Sometimes they don’t even require a board seat, which is very attractive to entrepreneurs who don’t want to give up control. 

For example, the New York-based alternative investment firm Tiger Global dominated headlines with 48 deals in the third quarter. It rarely takes board seats at its portfolio companies, which makes it “the perfect equity partner” for some entrepreneurs, according to Rob Freelen, head of venture capital relationship management at Silicon Valley Bank.

“Some consider this to be a flaw in their model, but others applaud their conviction and find Tiger’s pitch to be tremendously enticing because it affords entrepreneurs access to capital with less investor oversight,” Freelen said.

“It’s a really pivotal year for nontraditional investors. They are obviously throwing their weight into venture capital right now,” Stanford concluded. “At the beginning of the pandemic, maybe the entire industry stopped for a quick minute. But nontraditional investors really came back strong and doubled down on their [VC] strategy” in the last 18 months. 

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