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Dec. 15, 2020, 9:47 a.m. EST

Venture capital investors are preparing to pour money into biotech and software in 2021

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By David Spreng

When the Covid-19 pandemic began to take hold in the U.S. in March and expand across the country, the financial markets had their greatest period of volatility in more than a decade.

Despite the turmoil, the U.S. venture capital ecosystem proved its resilience and performed surprisingly well in 2020.

Looking forward to 2021, we see another strong year for venture capital and a great awakening for venture debt, a type of debt financing provided to venture-backed companies by specialized banks or non-bank lenders that is less dilutive than equity financing and often complementary to venture capital.

When it comes to capitalization trends in 2021, it is clear that Covid has done little to slow the rapid growth of software as a service (SaaS). For proof, look no further than the successful Snowflake /zigman2/quotes/220991541/composite SNOW -1.58% IPO. (Snowflake is a cloud data-warehousing company that recently raised $3 billion in the biggest software IPO ever.)

The SaaS market has catapulted from only 2% of the software market in 2009 to 23% in 2020, reaching $100 billion in revenue, according to Synergy Research Group. SaaS offerings impact nearly every aspect of work, as well as many household activities.

Whether it’s customer relation management (CRM), enterprise resource planning, and human capital management (HCM) for businesses, or consumer-facing efforts in ecommerce, personal organization, calendaring, photo management and entertainment (music to video), SaaS shows no sign of slowing its upward trajectory in the coming year.

Life sciences valuations will remain high through 2021, especially for biopharmaceutical companies; the pandemic highlighted the profound need for medical innovation.

It also pulled back the curtain on numerous inefficiencies about the way drugs, therapies and treatments are conceived, manufactured and distributed. In the coming year, capital providers will seek out companies working to enhance these pathways.

According to third-quarter research from the National Venture Capital Association, pharmaceutical and biotech investing is on pace to shatter deal value records. Late-stage venture capital in these two sectors is seeing a notable boost, with biotech in particular seeing strong exits that will push increased valuations.

ARCH Venture’s Bob Nelson teamed up with other life sciences investors and health-care experts — including former FDA chief Scott Gottlieb — to establish an $800 million fund . The goal of this fund is to dramatically improve and protect biopharmaceutical manufacturing.

Elements of Operation Warp Speed, the partnership between the government and the private sector, now offer a blueprint for ways of developing improved therapeutics and treatments for other deadly diseases including cancer, diabetes, heart disease and chronic obstructive pulmonary disease (COPD), to name a few, that will inform and enhance new developments in 2021.

During the pandemic, according to PitchBook, venture debt returns have had the lowest volatility of all direct lending. In 2021, we expect to see an increase in investment in the aforementioned vertical industries that includes more dollars allocated to debt.

According to the Runway Venture Debt Review, more than 80% of 400-plus entrepreneurs surveyed indicated that they are becoming more comfortable using venture debt.

However, many still have some common misconceptions, and there’s a need for further education. Given everything that has happened this year, in 2021 entrepreneurs will get smarter about how to better use alternatives to venture equity as a part of their overarching capitalization strategies, and drive one of the best years in recent memory for venture debt financing.

A focus on environmental, social and governance (ESG) is already common in private equity, and in the coming year we expect ESG to play a more prominent role in venture capital.

The impacts of the coronavirus pandemic are shifting focus on the entrepreneurial journey and the relationship between business owners, managers and providers of capital.

In the coming year it won’t be just about the economics of a business, it will be increasingly about the vision, ethics and outcomes that a business achieves. Entrepreneurs will increasingly steer away from sources of capital with the potential to dictate the direction, mission and ethos of their business.

In the coming year we expect that continuing low-interest rates combined with more future certainty from vaccines, will bring new entrants chasing yields into the venture debt space. Venture equity will continue to be “cheap” for strong companies, and equity funds will likely be lowering return targets.

From a valuation perspective, venture debt can be a solution for companies that are waiting for that “right valuation” before an equity raise. Companies will be looking for the additional runway to enable them to execute on their plans or pivots, particularly those driven by Covid, and then strike the equity markets at the optimal valuation.

In 2021 we will see a continuation of the frothy public market valuation and rebounding corporate profits that will drive value and support for potential exits. This will push entrepreneurs to be thoughtful about taking on additional equity and potential dilution.

Finally, relying on mergers and acquisitions (M&A) to augment or reposition businesses for a digital future — one of the key lessons uncovered from the pandemic — will result in an M&A boom for VC-backed portfolio companies. This will drive an increase in the use of non-dilutive financing as a bridge to an M&A event.

While the pandemic has inextricably transformed the way we view the world, business and capitalization, it’s always important to remember the words of Socrates: “The secret of change is to focus all of your energy not on fighting the old, but on building the new.”

If one thing is certain in 2021, there will be no shortage of “new” businesses to support, as well as ways to fund and grow them.

David Spreng is founder, CEO and CIO of Runway Growth Capital, which provides loans of $10 million to $75 million to companies in the U.S. and Canada. As a venture capitalist, he was active in the formation and development of about 50 technology companies with 18 IPOs.

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