Surveying the changing landscape of venture capital

For institutions and ultra-affluent looking to diversify into alternative investments, venture capital has traditionally been one of the most exciting and challenging spaces to get into. A major subcategory within the private markets, VC firms are probably best-known for providing the financial kick-start fledgling tech companies need to get off the ground and, eventually, mature into high-flying technology firms.

Because they use a specialized strategy, venture capital funds have management fees typically in the in the neighbourhood of 2% to 2.5%, which may sound like a steep price of entry in today’s zero-fee investing world. But with high returns that can easily blow past 15%, that may very well be worth it.

Because it has been so effective and beneficial for both businesses and large investors, we can expect the nature of venture capital investment to remain fundamentally the same. But because of certain technological, industry, and market disruptions, some aspects of the business are definitely changing.

First things first: what is venture capital?

So what is venture capital exactly? It’s a specific type of private equity where investors make investments in small, early-stage enterprises in order to help them grow. The investors get an ownership position in the firm, which gives them the right to participate in the decision-making process. Often, they also provide support in the form of technical and managerial experience, access to a network of industry contacts, and other resources to assist in the startup’s development.

VCs expanding their portfolios with care

One of the major trends in venture capital has been the widening opportunity set for venture capitalists. Given the increasingly global and digitized landscape of investment, geographical boundaries have become less of a concern for general partners. There’s no denying the resonance and appeal of Silicon Valley, but tech-focused investors are looking at more distant horizons, casting their eyes on destinations as far as Asia.

Diversification isn’t just about location. With COVID’s impact on certain industries still fresh in their minds, players in the venture capital space are considering less concentrated strategies and looking at a wider diversity of companies. Rather than just focusing on disruptive “unicorn” companies, some are also looking at “zebra” companies, so called because they are both black and white – pursuing profit while helping to solve societal problems through their business models and operations.

Still, that doesn’t mean investors shouldn’t be cautious. While VC firms are always on the hunt for areas to have their capital invested, the recent upheaval in the economy and public markets have taught them to favour companies with solid paths to profitability.

A growing opportunity for fractional CFOs

Following the euphoric markets of 2021, which were buoyed in part by the availability of easy money, the venture capital industry has seen a number of high-flying companies crash to earth. The steep drops in valuations mirrored the experience of many publicly listed tech companies, and have prompted several global VC firms to direct more fiscal prudence among their portfolio companies.

As VC investors and startups increasingly view cash preservation as essential, there’s an increasing need for early-stage enterprises to show their innovative business models are operating on a solid financial foundation. But because not all fledgling companies have the budget or size to justify a full-time chief financial officer, there’s a growing appetite for so-called “fractional CFOs,” who can render their services on a contractual basis.

A startup may not need a part-time CFO right away; they’ll want to consider it when the size and complexity of revenue starts to overwhelm the existing finance team, which generally happens during the series B funding round. When the business sees an increasing range of stakeholders, a fractional CFO may step in and identify key pain points, as well as anticipate and get ahead of future challenges.

Getting an edge with alternative data

One of the most enduring venture capital trends in recent history has been the use of non-traditional data sources. In the public markets, investors have mainly based their decisions based on stock price movements as well as company disclosures, financial statements, and other corporate reports. But with more listening tools and intelligence resources at their fingertips, large institutions playing in the VC space are able to carve out an enduring advantage.

As consumers and businesses increasingly move online, credit card transaction data and social media accounts are providing a rich trove of information that can provide insights to inform investment decisions. The most cutting-edge venture capital funds invest in satellite image data, as well as AI-based tools to scrape online and digital content for important clues about people’s behaviour and sentiment surrounding a particular business.

With new streams of alternative data to draw from, venture capitalists are able to discover distressed companies that are most in need of their funding. They can also build models to gauge the growth potential of a specific product, as well as monitor changes in a firm’s popularity. It’s often been said that data is the new oil, and that shift is only getting stronger.

Sustainable investing takes hold

One of the most distinct trends in venture capital for 2022 is the growing support for sustainability. While VC in the past might have been focused on achieving eye-watering returns, today’s investors are adopting a broader view and playing a longer game.

Increasingly, sophisticated institutions and individuals are looking for VC investment opportunities that don’t just offer strong performance, but are backed by strong convictions. By investing in businesses that operate with an eye on social justice, gender equality, climate change, and labour rights – just to name a few – limited partners are hoping to make a positive impact.

It’s not just about altruism, either. In the past few months, skyrocketing energy prices across the world have raised concerns over energy dependencies. With the growing realization that many countries need to wean themselves off traditional carbon-heavy energy sources, global VC firms have been increasingly focused on alternative technologies like electric vehicles and batteries; hydrogen-based technologies, small-scale nuclear plants, and other variations of cleantech are also poised to gain traction.

Technology will continue to stand out

It’s almost a cliché at this point, but firms looking to invest in early-stage companies will continue to focus on tech, and for good reason.

With the continued availability of data and exponential increases in computing power, the tailwinds for AI are blowing strong. At this point, it seems the applications and potential benefits are only limited by the imagination: self-driving vehicles continue to capture headlines, and venture capitalists will also look at AI-powered firms that tap into more essential corners of the economy like warehousing and logistics.

Similarly, fintech should continue to occupy a spot among the top venture capital trends of 2022. And with the continued momentum of digitization that was accelerated by the COVID-19 pandemic, entire industries are at increased risk of attacks from hackers and other bad actors, which raises the addressable opportunity for cybersecurity-focused businesses.