It has been a good year, in fact a good decade, to be invested in the venture capital market.

2021 has provided a bumper period of returns and liquidity for VC funds: realized $582.5bn from the sale or public listing of US portfolio companies in the first nine months, more than double the capital banked in either of the previous two years as a whole (and over 4x the level from 2017 and 2018).

Pitchbook data also shows that VC was the highest performing asset class across private markets, with a return rate of 19.8% in the first quarter alone. That extends an already growing record of outperformance. Over the last decade, VC has been either the highest or second-highest performing strategy in private markets in six out of ten years (up to and including Q1 2021).

As the pace picks up on exits, momentum is also building at the early stage, with funds equally active in making new investments. In the US, $82.8 billion in capital was deployed across over 3,500 deals in Q3, part of $238.7b invested during 2021 so far. That amounts to 43% more VC capital invested in the first 9 months of this year than 2020 as a whole, and a 67% increase from the 2019 total.

These are extraordinary figures that deserve to be explored and explained in more detail. They have arisen from a range of factors, some long-term developments and others more immediate catalysts that have helped to reshape market dynamics and demand patterns.

In particular, we believe there are three trends that have helped to drive this record-breaking run for VC, and which may offer some indication about where the market goes next.

1. A broader capital base

In the first three quarters of 2021, US VCs raised $96b of new investment, a record amount of capital that flowed from a broader and more diversified investor base.

The median new VC fund in 2021 showed participation by 64 limited partners (LPs), more than double the figure for those that raised funding in 2016. LPs are not just increasing in number. Their identity is also changing, as investors who were previously tangential players in VC increase their allocation. The average family office, for example, currently holds investments in 10 VC funds and plans to add another six over the next 12 months.

In parallel with a diversifying LP cohort is the changing face of VCs themselves. While specialist, standalone funds are still the industry’s cornerstone, they are increasingly joined by investors such as hedge funds and corporate VC funds – global companies that participate in VC as strategic investors in innovative areas of their industry. These ‘nontraditional’ investors have done deals topping $97b in 2021 to date, far exceeding their level of investment from previous years.

As this suggests, the VC boom is not simply the product of activity from existing participants. It also represents the arrival at scale of new sources of capital into the market – engines of growth which could continue to provide fuel well into the future.

2. A bigger opportunity set

As the volume of VC capital in the market increases, funds are broadening the focus of their investments.

While the US continues to be at the centre of the global VC industry, activity is also surging elsewhere. In the first half of 2021, Europe enjoyed both a record level of VC investment and a notable increase in its market share. In a fast-rising market, European start-ups received 20% of global VC investment, up from 13-14% two years earlier.

In 2021 alone, this funding has given rise to over 70 European ‘unicorn’ companies (start-ups valued in excess of $1b), more than three times the number that has emerged from China this year. In parallel, the growing presence of major US funds in Europe, as they hire partners locally and step up the pace of their investments, is further evidence of Europe’s booming technology sector – and the broader opportunity set for global VC it is helping to create.

VC’s opportunity set is growing into new sectors as well as geographies. Climate tech start-ups attracted over $30bn of VC capital in the first nine months of 2021, a 30% increase on the previous year, as investors turn their attention to areas including battery technology, carbon capture and the infrastructure for electric vehicles.

Even more nascent are areas of emerging technology including robotics ($8bn year-to-date) and quantum computing ($728.1m). The upshot is that VC is still only scratching the surface in areas of innovation that could become significant drivers of growth, value creation and investment returns in the years ahead. Despite the recent volume of investment, there are whole areas of technology that remain largely untapped for investors: sources of potential opportunity as innovation matures.

3. A rising demand curve

VC has also benefited from the soaring demand for technology solutions that has followed the disruption and dislocation of the Covid-19 pandemic. A study by McKinsey last year found that, as a result of the pandemic, organizations accelerated adoption of digital solutions in their operations and supply chains by 3-4 years on average.

Looking ahead, there is no sign of this activity slowing. Gartner’s CEO Survey for 2021 found that 83% are planning to increase their forward investments in digital capabilities, the only area in which investment intentions grew year-on-year.

In other words, demand is accelerating in enterprise software, still the category which accounts for more VC investment than any other. VC-backed companies are being boosted not only by the rising tide of investment capital, but by the pull factor of demand from a growing cohort of enterprise customers looking to manage, secure and optimize the data and digital workflows that increasingly provide their organizational backbone. The investment appetite for early-stage software companies may never have been greater, but nor has the future growth runway for these start-ups ever been so long.

What next?

In any market, the past is not an accurate guide to the future and the direction of travel is uncertain. VC is no exception. At the beginning of 2020, no-one could have predicted the combination of circumstances that would accelerate digital transformation across the global economy and provide such a strong tailwind to technology companies and investors. Nor should anyone claim with total confidence what the VC market is likely to do in the next year, or even five years.

At the same time, we believe the trends outlined above demonstrate that VC’s recent run of performance is built on strong foundations: the product of rising corporate demand for technology services, a growing opportunity set for investors, and increasing participation in VC among a new cohort of investors. These are trends that we believe to be long-term in their significance, and favourable for long-term investors.

We will be sharing more insights in the coming months, including from the perspective of fund managers and their portfolio companies, and we welcome your thoughts and feedback.