Lawyer and Legal Journalist Bob Ambrogi led an expert panel analyzing the findings of a new report titled "Betting on the Post-Covid Future: The Litera Pitchbook Venture Capital Report." His guests were Sherry Kappel, Evangelist at Litera, and Alex Lykken, Senior Analyst at Pitchbook.
Lykken began by pointing out the unprecedented level of deal activity in 2021. VC deals reached a value of a billion dollars in each quarter, an unprecedented level of aggregated deal value. The activity emerged after a relatively subdued 2020, as investors oriented themselves in the new realities of the pandemic.
While most sectors were active, certain pockets of the market are driving the current VC ecosystem, and not every aspect of the global startup scene is increasing at the same pace.
The Pandemic as a Driver
Was the pandemic a driver of huge deal volumes? Lykken noted several ways that Covid-19 changed business and consumer behaviors. People were interacting in new ways, and buying goods in new ways. Tele-medicine took off. The changes cut across many industries—consumer, legal, retail, healthcare. Many investors were clearly excited by the possibilities for the technologies and services that could fill the gaps.
Kappel noted that in many ways the timing was right for many industries. If we didn't have the technologies we now have—document management, collaboration—the pandemic would have hit much harder. "It was astonishing to see how quickly people picked up on technology and immediately saw it as an essential tool." Once the use of technology became a requirement for day-to-day work, the resistance fell away. Entire industries—including legal—made big investments in making work easier.
Technology was ready for the pandemic, said Kappel, and the agility that was shown just a few months into the pandemic far exceeded the progress that had been made in previous years.
Was There Some Overreach on Valuations?
Valuations hit new highs, not just deal volume, noted Lykken. Late-stage valuations almost doubled between 2020 and 2021, to an average of $84.3 million. Early stage and angel deal sizes also jumped.
Lykken believes that the conditions made it easier to identify the companies that are winners, and buyers were not hesitant to bet on the companies reinventing markets. Even before Covid-19, he noted, there was a lot of optimism in the market. In the end, the high valuations are all about that optimism. Putting a number on a company involves looking ahead. The deal values represent real confidence in a model or solution. The environment also emboldened founders to ask for more, he added.
Will the Optimism Last?
Not all of these companies will succeed, of course. Lykken recalled the dot.com days of the early 2000s, where every tech company's mantra was "this changes everything." That kind of talk makes him a little nervous, he admitted.
But he also believes that this time around, the technologies getting funding are more well-grounded. Companies are seeing the promise of their offerings and starting to prove it.
Kappel observed that innovation is becoming so important in so many sectors, with many pieces of many puzzles coming together. She sees more comprehensive platforms and cohesive sets of tools coming together in many industries, including the legal sector.
Lykken used gaming as an example of a sector that might have been dismissed as hype in an earlier age, but which is now getting a lot of attention because there are so many gaming-like applications for the underlying technology, in areas such as training, workflow, manufacturing, and medicine.
The Changing Geography of VC Deals – and Implications for Lawyers
Cross-border deals accounted for $123 billion of the year's activity, which is 73% higher than the previous record.
Part of the jump might be due to the changing geography of deals. In a world where investors and startups had to work on deals remotely, suddenly it didn't make sense to only look for deals in one's own back yard. According to Lykken, even the number of deals crossing borders within the US was up; investors on the coasts in Silicon Valley or New York suddenly discovered that good companies were available between the coasts, and they became comfortable working through those deals in a virtual environment rather than always working face-to-face.
That opening of new geographic markets has implications for lawyers, too, as M&A teams gain the same capability of being everywhere, anytime through virtual collaboration and deal platforms. A mastery of technology will increase the ability of lawyers to reach those new clients in previously inaccessible places.
Non-Traditional Investors and Cross-Border Deals
Lykken noted that this year's VC deals involved many more non-traditional investors, including hedge funds, private equity, mutual funds, and sovereign wealth funds. These non-traditional players were particularly active in late-stage rounds.
He used the example of Northvolt, a Swedish lithium-ion battery producer, which raised a $2.75 billion Series E in June from four Swedish pension funds, Goldman Sachs, Volkswagen, IKEA, and the OMERS Administration Corporation.
The VC ecosystems getting bigger in this way also has implications for M&A lawyers, who will increasingly find themselves working on deals with a much more diverse set of clients and stakeholders.
Changing Characteristics of Today's Startups
Ambrogi noted that much of the activity in 2021 was simply efforts to buy technology rather than building it, with the intention of bolting the tech onto other platforms and companies. Lykken agreed—VC add-ons and buyouts of startups were a big part of the growth.
He added that one thing has clearly changed: in prior years, startups were typically never making money by the time of VC investments. Today, many more of them are making money. Startups have become better (two decades after the dot.com era) at building revenue models that work. VCs can now invest in companies with well-defined paths to growth.
Ambrogi, who closely follows the legal tech industry, noted that the same thing held true with today's legal tech startups—many more of them have viable revenue streams and are successfully established before taking on VC money. Rounds of investments are definitely fueling legal tech growth, but the startups are moving up from a higher performance baseline that better technology is enabling.
Can Law Firms Keep Up?
Kappel drew a straight line between the increasing deal volumes and velocity and the sometimes over-extended nature of legal work. M&A teams are exhausted and struggling to catch their breath. The risk of missing opportunities due to lack of capacity is real. In that environment, she said, leaning on new legal technologies has been an essential part of keeping up.
The Litera-Pitchbook report includes some interviews with M&A lawyers David Brekke and Andrew Sparks from Goodwin. Sparks confirmed that the entire VC ecosystem—from investors to startups to lawyers and other service providers—are impacted by the pace of deals, and they are recruiting talent and acquiring technology just to keep up. Brekke identified due diligence as one area where tech has played a big role: "The pandemic forced the venture capital world to rethink due diligence with technology-driven solutions that brought incredible efficiencies to the process. With virtual data rooms, record digitization, [z]oom meetings, and digital collaboration tools, the due diligence process can be done just as thoroughly as it was prior to 2020, but now with greater speed and at a smaller cost."
Posted in Venture Capital