The shift within the venture capital industry, moving from caution during the first and second quarters to a more optimistic outlook in the third quarter, is a noteworthy development. To fully grasp the dynamics of private capital investment in 2020, we have analyzed both the venture capital landscape in the United States and the global trends this week.

As a recap, a substantial amount of private funding was accessible to startups in the third quarter, with a noticeable preference for investments in companies at a more advanced stage of development.

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Investments in later-stage companies typically involve larger sums of money than those in earlier-stage ventures, naturally leading to a greater allocation of capital. However, the third quarter of 2020 was particularly remarkable due to the significant disparity between funding for late-stage companies and that available to younger startups.

For instance, data from CB Insights indicates that 54% of all venture capital invested in the United States during the third quarter was directed towards funding rounds of $100 million or more. This translated to 88 investment rounds – an unprecedented number – totaling $19.8 billion.

The remaining 46% of the venture capital funds in the United States during Q3 were distributed among the other 1,373 investment deals.

Although the overall venture capital activity both domestically and internationally demonstrated improvement – with increased investment in Europe and Asia, and a resurgence in seed-stage deal volume in the US – the late-stage funding data remains particularly striking.

For our international audience, please note that the data we currently possess is primarily focused on the United States. Therefore, our analysis of the surge in late-stage funding will be viewed through a domestic perspective. While the core observations should generally be applicable on a wider scale, we will consistently strive to maintain a broad viewpoint.

A late-stage takeover

Returning to our discussion, data from PitchBook regarding the third quarter provides insight into why venture capital investments have increasingly favored startups in their later phases of development.

Several instances illustrate this point: During Q3 2020, the proportion of U.S. venture capital deals valued at $25 million or higher increased to over 18%, establishing a new high point dating back to at least 2015. PitchBook observes that “over 30.5% of late-stage VC transactions exceed $25 million and account for 75.5% of the total value at that stage.” The firm defines late-stage VC as Series C funding and subsequent rounds.

The same data indicates that late-stage VC activity is projected to reach record levels in 2020, with the combined total for the first three quarters of the year for U.S. startups almost matching the entire result from 2019, which was the second-highest year on record.

(It’s worth noting that the same patterns are influencing startups with female founders. As per the same Q3 report, late-stage funding rounds have consistently represented a greater share of the overall deal volume for female-founded companies in the United States since 2013, when they accounted for approximately 10% of the total volume. In 2020 to date, this figure has roughly doubled, marking the strongest performance of late-stage rounds as a percentage of domestic venture capital deals since at least 2010. This is a positive development for women who are building companies.)

We are observing a greater concentration of funds directed towards the largest investment rounds, and late-stage funding generally represents an increasing percentage of deal volume within the U.S. venture capital landscape.

The reason for this trend is a valid inquiry. Unicorn companies, at least in part, are a contributing factor. As the number of unexited unicorns grows, the total amount of capital they require naturally increases. Unicorns rarely achieve profitability, and some operate at significant losses. Therefore, assuming all other factors remain constant, a larger number of unicorns in the market will necessitate a greater overall capital investment.

Multiplying unicorns

The population of unicorn companies continues to increase. As previously noted this week, even with substantial unicorn liquidity events during the third quarter of 2020, the number of U.S.-based unicorns that hadn’t exited through an IPO or acquisition increased by two, moving from 214 in the second quarter of 2020 to 216 in the third quarter of 2020, as reported by CB Insights. This occurred despite 17 startups achieving unicorn status during that period. Therefore, the U.S. market almost managed to offset the growth in unicorn numbers through exits in the third quarter, but ultimately fell slightly short.

Considering there are 216 unicorn companies within the United States, and many more internationally, it’s understandable why a significant portion of venture capital is being directed towards them.

Unicorn companies that are slow to pursue exit strategies are consuming a large share of available funding! In fact, they are responsible for more than half of it.

It’s reasonable to see why investors remain willing to provide ongoing financial support to these unicorn businesses. The same report detailing the unicorn count also indicated that the aggregate value of U.S. unicorns increased to $646 billion in the third quarter, a rise from $593 billion in the first quarter.

Allowing these companies to fail is not an option, so they continue to secure additional funding.

Positive Developments

However, this situation isn't entirely negative. The effect of a significant portion of the venture capital sector focusing on highly-valued, late-stage companies – often referred to as "Peter Pan unicorns" – has been a substantial increase in the size of exits. PitchBook’s research indicates that the proportion of venture capital-supported U.S. private company exits valued at $100 million or higher has increased from approximately 40% in 2010 to around 65% (this figure is an estimation due to the chart’s presentation).

Concurrently, the percentage of American VC-backed private company exits reaching $500 million has seen a dramatic rise, moving from less than 10% of all exits in 2010 to over 20% in 2020. This growth in exits valued at $500 million or more, as a percentage of total exit volume, means the exit market is now predominantly focused on later-stage companies. According to PitchBook, exits of $500 million or more accounted for over 80% of the total dollar value of 2020 VC-backed private company exits. Including exits of $100 million and above covers almost the entirety of exit value.

In the United States, smaller exits involving venture capital-backed companies have become less common with the rise of the "unicorn" phenomenon.

Therefore, the shift of venture capital towards later-stage and larger investments is directly linked to the emergence of unicorns. This trend also presents a further question: What will occur with these highly-valued companies when conditions in the late-stage funding market deteriorate at some point in the future?