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The world’s largest investment funds are descending on Silicon Valley with unprecedented financial force, roiling the once-niche business of technology startup funding and crowding out traditional venture capitalists.

Hedge funds, mutual funds, pensions, sovereign-wealth groups and other financial institutions known as nontraditional investors in Silicon Valley have become the powertrain behind record-setting funding rounds and valuations. They were more active in the second quarter than in any previous period, participating in 42% of startup financing deals, and those deals accounted for more than three-quarters of all the invested capital, according to research firm PitchBook Data Inc.

These financial institutions have propelled a historic rally in startup financing. Investment in U.S. startups for the first half of the year hit $150 billion, eclipsing full-year funding every year before 2020 and on pace to nearly double last year’s record, according to a report from PitchBook.

The large asset firms have massive pools of capital, move quickly and are less likely to ask for board seats or involvement in company decisions, often making them more appealing to founders, according to interviews with investors and startup executives. The result has been a dizzying pace of deal making.

“It’s like speed dating but more extreme," said Peter Fishman, a longtime Silicon Valley tech professional who last year co-founded data-automation startup Mozart Data Inc.

Big money managers have long allocated some of their portfolios to invest in traditional venture-capital firms. But many started investing directly in startups around a decade ago in a near-zero interest-rate economy and after a decline in the number of publicly traded companies that started after the dot-com era, looking for better returns from tech companies that were staying private longer. Over the years, traditional venture capitalists often panned them as tourist investors and dumb money who lacked the particular skill set for startup investing.

But they stuck around and doubled down. Today, among the top 10 investors in startups by dollar amount, half are nontraditional venture investors, including Fidelity Investments Inc. and Tiger Global Management. The number of startup funding rounds that include only nontraditional VC investors and zero venture-capital firms has doubled over the past 10 years, according to PitchBook.

U.K.-based asset management firm Baillie Gifford, which has more than $450 billion under management, made its first startup investment in 2012, and in 2019 launched a dedicated private-market portfolio “to really start pouring serious amounts of capital into the late-stage private markets," portfolio manager Robert Natzler said.

Some traditional venture firms are scrapping old practices to keep pace. To move quickly, some venture capitalists said they are cutting back on audits and customer checks, and taking a startup’s word on profit and loss.

“There are no VC funds with pricing discipline. All of us have caved," venture capitalist Keith Rabois tweeted last month.

From 2016 through 2019, there were on average 35 deals a month with funding rounds that reached $100 million or more, according to data provider CB Insights. This year, it is 126 deals a month.

All that money has sent valuations soaring, which boosts profits on paper for all types of startup investors and their founders. Five years ago, 14 startups attained valuations of $1 billion or more during the April through June quarter, according to CB Insights. This year, 136 companies achieved that valuation during the three-month period.

Boston-based company Motif FoodWorks Inc., which makes plant-based meat and dairy substitutes, is backed mostly by nontraditional investors, and its June funding round of $226 million was led by the Ontario Teachers’ Pension Plan and BlackRock Inc.-managed funds, Chief Executive Jonathan McIntyre said.

Mr. McIntyre said traditional venture capitalists balked at the fundraising amount and valuation for his two-year-old startup. The Ontario pension fund and BlackRock will each get observer seats on the board, rather than full board voting rights.

A windfall from the IPO boom has reinforced investors’ methodology. About 95% of the proceeds from initial public offerings and other exits such as acquisitions last year were from companies that had been backed by nontraditional investors, according to PitchBook.

The shift to high-velocity investing has given founders more leverage. Some have scrapped the old pitch decks, showing up to investor meetings empty-handed, and are asking investors for freebies upfront—such as the names and numbers of prospective customers—before agreeing to let them join a funding round, according to investors and entrepreneurs. More founders are asking for, and getting, so-called refreshes of their equity, when their ownership stake goes up a couple percentage points after a funding round, instead of down, said one venture capitalist.

“I have to be flexible and give much more than I used to," said Andy Boyd, a longtime Fidelity executive who helped pioneer that firm’s entry into startup investing, and now runs venture-capital firm Bramalea Partners. That includes giving “insights, data, connections and to make these connections prior to any investment opportunity."

Nontraditional investors tend to have larger capital supplies and lower return thresholds than traditional venture firms, which gives them more wiggle room on valuations. Deals led by nontraditional investors have valuations that are on average five times the valuations in deals led by traditional venture capitalists, data from PitchBook show.

Nontraditional investors also are often amenable to nontraditional deal terms. Beta Technologies Inc. in May raised about $400 million in its first round of institutional funding to build electric aircraft. Venture capitalists demurred on the investment round for the four-year-old startup, and mutual-fund manager Fidelity led the deal, according to a person familiar with the matter.

Although Fidelity didn’t offer the highest valuation, the person said, it did agree to an unusual condition: More than 70 Beta employees could invest in the round and receive the same class of stock at the same price as Fidelity.

A spokesman for Fidelity declined to comment.

There are headwinds. Inflation and a possible interest-rate increase are likely to reduce the amount of available cheap cash, deter nontraditional investors from high-risk and long-term bets like startups, and compress valuations in both the public stock market and among startups, according to research by academics and economists. President Biden’s proposed tax increases would raise capital-gains taxes and corporate taxes, which could also stem investor activity.

Rich Wong, a partner at venture-capital firm Accel, is hoping for some respite from the frothiness. “We would expect to see some capital and valuations pull back," he said.

This story has been published from a wire agency feed without modifications to the text

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