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The Black Swan Year: How 2020 Impacted Venture Investing and Performance

2020 was a year that profoundly disrupted nearly every aspect of life, so it’s no surprise that the pandemic’s effects made ripples throughout the venture landscape too.

Sapphire Partners invests in a portfolio of early-stage venture funds across the U.S., Europe, and Israel, comprising over 2,000 underlying portfolio companies. We believe this provides us with a unique, bird’s eye view of the venture ecosystem.1

In the spirit of our #OpenLP initiative, and leveraging our proprietary dataset, we took the opportunity to examine how this groundbreaking year altered the venture and startup scene.

So, without further ado, here are the four key take-aways we gleaned from Sapphire Partners’ portfolio:

Among VC’s, COVID-19’s initial impact was a story of losers and winners. Then came the tailwind.

With the initial shock of the pandemic, including a sharp sell off in public markets, record unemployment claims, global lockdown on travel, and shelter-in-place mandates, we anticipated that Q1 would be most impacted by COVID-19. 

To our surprise, Sapphire Partners’ portfolio net asset value in Q1 2020 was more or less flat quarter-over-quarter, speaking to the overall strength of the technology sector compared to the broader market.2 Peeling one layer back, however, revealed a more barbell-like distribution of performance, with winners netting out a similar number of losers, ultimately resulting in flat performance for the quarter.

To illustrate this point, around 40% of our underlying funds reported a valuation shift greater than 5%, with exactly half reporting positive performance and half reporting negative performance. A very bifurcated story! (As comparison, in Q1 2019, only 26% of our underlying funds reported a 5%+ value change and among those that did, only 14% reported negative performance.)

As the year progressed, however, we saw the resilience of the tech sector truly bear out within our portfolio. In keeping with the conventional narrative of the technology sector remaining relatively immune to, and in some cases benefitting from, COVID-19, the pandemic acted as a broader tailwind to our portfolio in Q2 and Q3 2020. This tailwind was widely felt, with 70% of the 5%+ movers exhibiting positive performance in Q2 and 86% in Q3.

While we don’t yet have a full picture of 2020’s performance (LP’s receive data one quarter lagged), we are very optimistic about Q4 and 2020 in general. The technology and software sectors have proven to be a boon during these unprecedented times, and we anticipate that ultimately being reflected in the final tally. 

No surprises – venture continues to be a power law business. Outlier breakouts are still needed for outsized performance.

Among our funds that are marked at 3x TVPI or higher, the top value driver company currently represents ~50% of the funds’ total value on average. The top two value drivers represent a whopping ~60%, and the top three drivers represent ~70%.

Across Sapphire Partners’ entire portfolio of over 2,000 underlying companies, the top five companies represent 15% of our total value and the top two companies represent 11%. 

Swing for the fences everyone!

What recession? Investment pacing picks up and fundraising cadences compress further.

LPs often use capital calls as insight into the investment pacing of a specific manager and/or fund. It’s a useful input, as it’s real-time and not subject to the quarter-lagged nature of standard GP reporting. 

In early-to-mid March, as the pandemic hit the public markets in full force, we wondered if our funds would increase capital calls to help bolster their companies through a down-turn.

While we did not see a drastic uptick in the rate of capital calls in 2020 (moving from 24% in 2019 to 25% in 2020), we saw a continued, longer-term trend of increasing rates of capital calls more generally. For example, the aforementioned 2019 and 2020 capital call rates are substantially higher than the ~20% rates we saw in 2018 and earlier.3

While the data illustrates a somewhat muted effect on capital calls in aggregate, initially we observed our managers call capital to support strong existing portfolio companies, while slowing down investments in new companies. By summer, however, our managers were off to the races, making new investments at rates similar to, or in some cases higher than, pre-COVID rates.

As one would expect, increased investment pacing has resulted in quicker fundraising timelines. Among our 2020 vintage managers, the average time between the first capital call and the prior fund’s first capital call was 2.4 years. By comparison, this number was 3.3 years for our 2019 vintage managers. 

Keeping it local. While U.S. managers held off on ramping up international investment, domestic geographic diversification took flight.

Given the rise of remote work, we expected (and anecdotally observed) a de-emphasis of geographic investment mandates, with investment teams more willing to take meetings and run fully remote diligence processes with entrepreneurs regardless of their physical location. 

Contrary to what we expected, however, our managers based in the U.S. did not substantially increase their investing internationally. On average, 14% of our U.S. managers’ new investment in 2020 was deployed internationally, essentially flat from 2019. It is worth noting that, despite the 2020 plateau, this number has been steadily rising in recent years, from sub-10% in 2016, to around 10% in 2017 and 2018.

While our U.S. funds did not drastically expand international investment in 2020, our California-based U.S. funds did invest substantially more in other states. Among our California-based funds, 43% of new investments were deployed outside of California in 2020, a steady and consistent increase from 37% in 2019 and 29% back in 2016.

We continue to believe the Bay Area will be an important ecosystem for venture capital and technology. But, echoing Fred Wilson’s argument, the pandemic has clearly catalyzed a growing comfort in making investments remotely, leading to a widening in geographic scope for many venture investors. 

While it is unclear to what degree this dynamic will persist post-pandemic, with many teams now comfortable operating remotely, we believe this is a reality that is here to stay.

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This is the first time we are publicly sharing insights from the proprietary data our team has compiled over the years. Keeping in mind obvious confidentiality/privacy implications, this is something we hope to do more of going forward.

We would love to hear any feedback or specific areas of benchmarking and/or data insights that you would find helpful or interesting. 

Feel free to reach out to me at thomas@sapphireventures.com.

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1 While the Sapphire Partners’ portfolio spans the better part of a decade, multiple geographies, and various stages, it is important to note that our portfolio is not necessarily representative of the venture market as a whole. The data presented are compiled under internal analysis conducted by Sapphire Partners using proprietary data that is not regularly made available to the public.

2 Performance methodology used in internal analysis and presented in this article accounts for any impacts due to interim cash flows by subtracting out capital calls and adding back in distributions and is calculated on a gross of fees basis.

3 At any given point in time, funds can have drastically different rates of capital calls/investment pacing depending on if a fund is in its investment period versus harvesting period. To account for this, we looked at capital calls as a percentage of fund size on a three-year cohort basis. For example, for 2020 pacing we only calculated within the 2018, 2019, and 2020 vintage funds.

Disclaimer: Nothing presented within this article is intended to constitute investment advice, and under no circumstances should any information provided herein be used or considered as an offer to sell or a solicitation of an offer to buy an interest in any investment fund managed by Sapphire Ventures, LLC (“Sapphire”). Information provided reflects Sapphires’ views as of a time, whereby such views are subject to change at any point and Sapphire shall not be obligated to provide notice of any change.While Sapphire has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, or completeness of third-party information presented within this article. Due to various risks and uncertainties, actual events, results or the actual experience may differ materially from those reflected or contemplated in statements made. Nothing contained in this article may be relied upon as a guarantee or assurance as to the future success of any particular company. Past performance is not indicative of future results.