How to tell a trend from a bubble — 8 tips
For venture capital funds, in contrast to later stage funds, it is vital to be able to distinguish between solutions that will be of interest for a long time from those in which interest will quickly fade.
Where is the trap?
You fall into the trap if you invest in:
1. Solutions that improve, but do not change the industry
Video conferencing services, e-commerce platforms, educational platforms have benefited from the pandemic. However, this growth is not due to the fact that they are insanely convenient and amazing solutions to pressing problems. They still have many problems with usability, data security, and compliance with regulatory requirements.
They could generate high returns in the short term, but they will not generate long-term returns for investors. By the way, at the beginning of 2021, Goldman Sachs analysts named 39 companies that, in their opinion, are bubbles. Interestingly, Zoom is one of them.
When investing in a company during a pandemic, you need to think about:
What are the chances that its growth rate will remain high after the pandemic? Will the new consumer habits of service hold out, and will the aftermath of the COVID-19 pandemic set a new norm? Which of the solutions that fired the pandemic will naturally disappear?
In my opinion, now is the best time not to invest in companies from these categories, but to exit them with high returns. So did the team at Pluralsight, an American company that offers many online courses for developers. In December 2020, Vista Equity Partners, a private investment company specializing in educational software, agreed to buy Pluralsight for $ 3.5 billion.
2. Solutions that grow regardless of the pandemic
European fintech companies raised more in 2020 than companies from any other industry. For example, Klarna is a Swedish bank that is best known for its “buy now — pay later ”- raised $ 850 million in two rounds, but now faced new and very stringent regulatory requirements in England.
Fintech has been growing for five years: in 2019–2020 alone, more than $ 23 billion was invested in European companies in this sector, according to Dealroom. Therefore, despite the fact that innovative financial solutions effectively create the basis of the digital economy, this segment is already overheated for investors and early stage venture capital funds.
3. Deeptech (“deep technologies”) with a development cycle of more than two years
Ambitious venture capitalists should pay attention to deeptech companies — companies whose main goal is to provide customers with technological solutions based on significant scientific or engineering problems. However, one should not hope for a quick return in such deeptech segments as biotechnology.
The development of vaccines and drugs for serious, sometimes fatal diseases, as well as the call of officials to create digital passports with vaccination marks, certainly drew the attention of investors to biotechnology:
British company Immunocore, which develops next-generation cancer drugs, received $ 130 million from General Atlantic and a number of other funds;
Freeline Therapeutics, a developer of a blood clotting disorder hemophilia B gene therapy, has raised $ 120 million from its longtime investor Syncona.
These companies are in rounds B and C. Investors who enter such companies early should be prepared for subsequent rounds or significant results to take longer than two years.
Where is the trend?
2020 has shifted the focus of strategic venture capital investments from capital-intensive and experimental startups to startups with predictable growth models designed for the post-Covid world.
1. Deeptech with a focus on artificial intelligence (AI) and SaaS (software as a service)
According to the Dealroom platform, which collects data on startups and investors, the cumulative estimate of European startups deeptech in 2020 is approaching 700 billion euros, and in total deeptech accounted for about 25% of all European venture capital.
The success story can be shared by a startup from Romania UiPath, which creates a platform for automating routine tasks in large companies. In July 2020, he raised $ 225 million from a group of investors, including the Accel fund. It is noteworthy that earlier, the fund predicted that Europe would need at least 3 years to create a SaaS decacorn (this is the name for startups with revenues of more than $ 10 billion — RBC Pro), and UiPath appeared nine months later.
Deeptech startups take a little longer to grow compared to tech startups in general, but shorter compared to biotech startups — 2 years versus 1.5 years versus 2.5 years. However, in the long term, the exit opportunities for the investor are better, the economy is more predictable — in the case of UiPath, the robotic process automation (PRA) sector is growing at 60% per year regardless of the pandemic, and the focus on b2b adds confidence.
2. Generative adversarial networks (GAN)
While some investors have watched home entertainment platforms help people cope with isolation in 2020, others have focused on machine learning-driven advertising technologies.
A wide range of AI solutions help companies find leads, hyper-personalize messages, and improve ad spend and placement. Potentially the most interesting solutions are created within the paradigm of generative adversarial networks.
In a sense, GAN startups caught the wave in 2020: employers have fewer resources to create high-cost photo and video footage — this has forced investors to pay attention to AI models. But GAN can do much more than just create a photo. The technology can also be used to automatically translate videos, personalize video chats with clients, and train AI.
3. Drones
Drones ceased to be a toy and began to solve business problems from “last mile” delivery (like Manna Aero in Ireland) to construction control (like TraceAir in the USA) and even plant protection (like Fixar.Pro in Latvia). At the end of January 2021, the German Wingcopter raised $ 22 million in the Serie A round.
Whirlwind in the venture capital market: what is worth investing in in 2021 Investments RBC forecasts
It is much easier for drone users to obtain a license than manufacturers of many biotechnologies, such as bioprostheses. In addition, you can learn how to fly a drone in a short time, while less than a third of surgeons in the UK can perform heart replacement surgery. Undoubtedly, the use of unmanned technologies will go beyond COVID-19.
How to tell a trend from a bubble?
Funding suitable startups with fast growth rates, a strong go-to-market strategy, and a clear exit strategy are the path to the success of venture capitalists who invest in companies early on.
In order to distinguish a solution that is worth investing in at an early stage from a soap bubble, it is worth asking yourself a number of questions:
1. Is there a market and how does a startup fit in there?
2. Is the solution based on technology that has already been proven in the market?
3. Is further development progress and new applications possible?
4. What is the reason for the company’s growth and what will happen if external factors change?
5. Is it possible to modify the solution without special expenses?
6. Is licensing ahead and how difficult is it in each country and / or city of presence?
7. What compliance procedures are needed?
8. How is the industry developing in which a startup offers a solution, and how the related ones feel
industry? For example, is there enough data to train the AI? Are companies that have started implementing a similar solution growing?
