2021 was an extraordinary year for tech, with record financings, record valuations, and record IPOs. 2021 was also my first full year leading RBCx’s venture strategy, and it was an equally extraordinary year for us.
We deployed an unprecedented amount of capital through fund investments and new credit to venture capital and growth equity funds, and we launched several new financial products specifically designed for the industry.
Beyond software and digital technology, we sought to finance other segments of the innovation economy that we believe offer compelling opportunities for outsized impact and transformation. Together with our colleagues in RBC Capital Markets we invested in venture capital funds focused on healthcare and life sciences [1] [2], and as climate instability continues taking centre stage in the coming years, RBC will continue to cement its commitment to clean technologies and sustainability.
Suffice to say, it’s been a transformational period for the technology sector in Canada and around the world. In this 4-part series I will share my perspectives on the state of the market today, and where I believe we’re headed.
State of the Market in 2022
From my perspective, there are three distinct – and largely independent – phenomena propelling the present boom cycle: (1) a maturing Canadian ecosystem, (2) the proliferation of the crossover investment strategy in the United States, and (3) transient macroeconomic abnormalities.
In Part 2 I’ll discuss Canada’s Fund of Funds ecosystem, and the outsized role played by the federal and provincial governments within it. I’ll expand on why I believe this is a risk to a scaling innovation-based economy, but also why government involvement remains a necessary evil in the short-term.
In Part 3 I’ll discuss how the expansion of crossover investing in the U.S. is inadvertently creating valuation inflation and instability in early-stage portfolios. I’ll explain how I expect LPs to respond, and how emerging trends in venture capital might evolve in 2022 – namely the recent contractions in capital deployment cycles, hurdle rate erosion, and the rise of opportunity funds.
Finally, in Part 4 I’ll explore why macroeconomic conditions have propelled valuations upward, and how private tech markets might respond to rising inflation and rate increases. Additionally, I’ll explain why the innovation economy – in theory – will be especially susceptible to macroeconomic fluctuations.
I’ll briefly touch on these three themes below but stay tuned for deep dives on each individual theme in the coming weeks.
Canada’s Maturing Ecosystem
First and foremost, the Canadian tech ecosystem is trending towards a long-elusive critical mass. We now have a great crop of established public and growth-stage companies, repeat entrepreneurs, and experienced venture capital investors across sectors and stages. This is something to celebrate – and I’m hopeful this represents a permanent transformation for our ecosystem.
However, I remain concerned as it relates to our Fund of Funds ecosystem [3] and the outsized role played by government in that arena, which is unquestionably a potent exposure for the ecosystem’s long-term scalability.
This is a celebration of public policy, not an indictment. Unfortunately, public patronage cannot scale an ecosystem. Whereas U.S. and European markets have the means to aggregate and move private retail capital to venture assets, Canada continues to suffer from a dearth of infrastructure and an endemic conservatism when it comes to innovation. If we’re going to be stoic about it, this is a piece that’s proximately within our control.
All this being said, the record-breaking level of capital flowing into the ecosystem can only partially be rationalised as an outgrowth of a maturing ecosystem. It is, to a much more significant extent, an emanation of transient macro conditions and other extrinsic factors.
The Proliferation of the Crossover Strategy
On paper, swelling valuations are being substantially driven by a proliferation and expansion of broad-based, high-velocity crossover investment strategies. Think of crossover investors as asset managers with contiguous private and public market strategies. On the private market side, these investors typically focus on late-stage, pre-IPO growth equity, as companies theoretically “crossover” from private to public markets. Think Tiger Global, Coatue, Altimeter, et al.
These strategies are broad-based and high-velocity due to the scale and scope of the deployment, the passive nature and scalability of the deployment, and an unorthodox allocation to competitive firms, which creates natural diversification and risk-mitigation. These strategies equally rely on momentum – both in market share acquisition and in capital intake – of underlying portfolio companies, with a proximate offramp into public markets.
I’m not a naysayer on Tiger and its peers. I rather admire the model; I think it’s clever, and I think it’s here to stay. Unfortunately, an unintended consequence of the model is a distortion and artificial inflation of upstream early-stage portfolio valuations. This, in my opinion, will introduce unprecedented volatility into private markets, and will create a whole new set of challenges for VC LPs and GPs alike.
The Coming Macro Shifts
Finally, everything I just described has been made possible by an unusual macro environment, namely low interest rates, a decade of quantitative easing, and excessive liquidity being pumped into the system, all of which have underwritten the 2021 bull run. Investors have a lot of cash and nowhere to put it. In their hunt for yield, they’ve naturally allocated more capital to tech, from venture capital to growth equity, all the way to public markets.
Notwithstanding elaborate theories of intrinsic value, the clearing price of a good or service occurs wherever supply and demand intersect. There’s no doubt that the supply of capital in tech markets is well above its natural levels, and this has created asset bubbles across the market. Make no mistake, venture capital firms and technology companies are as intimately tethered to the macro environment as any other asset class, and it appears that things are about to change.
What This All Means
As an ecosystem, we’ve entered 2022 with amazing intrinsic tailwinds. That being said, untethering the innovation ecosystem from macro fluctuations and government policy will be a major challenge to overcome.
The glitter of 2021 is not gold. Valuations will likely adjust, and capital availability will likely contract, but that’s okay. I’m confident that if we all do our part, we can maintain the amazing momentum in 2022 and beyond.
There’s an inevitability to technology and innovation in the long-term. Summer soldiers will struggle in the coming years, but those with the heart and stomach to play the long game will continue to prosper.
- “RBC taps into biotech surge, investing in new Lumira venture fund” (The Globe and Mail, Sean Silcoff, February 1, 2021)
- “RBC makes second life sciences bet this year, backing BDC spinout Amplitude Venture Capital” (The Globe and Mail, Sean Silcoff, June 17, 2021)
- “Maturing Canadian Tech Ecosystem Still Dependent on Government Support: RBCx’s Anthony Mouchantaf” (BetaKit, Charlize Alcaraz, November 18, 2021)
