In 2021, U.S. startups raised over $329 billion. Not only did this break venture capital records of dollars raised per year, but also nearly doubled the previously held record of $166 billion in 2020, according to PitchBook. Investment activity, both in dollar volume and deal count, hit new highs for every startup stage, from seed and angel to early and late-stage investments. Likewise, investment activity for companies receiving their first equity round of institutional financing and companies raising venture capital mega-rounds (sized $100 million or more) also experienced a tour de force. An unprecedented number of companies either went public, were acquired or were bought out. With more capital in the market, startups in all phases of expansion have been able to earn sky-high valuations, in turn raising more capital, resulting in a cycle that defined 2021 and is starting to shape 2022.

However, in the beginning of this year, if you bought stock in a number of tech companies, you may have seen a dip, perhaps even a swift fall, depending on what stock you purchased. According to the Nasdaq 100 Technology Sector Index, those same unicorn tech stocks that performed so highly in 2021 were met with skepticism in early 2022, having fallen about 19 percent at the end of February from their high in November of 2021. Still, by the end of 2021, tech stocks as a whole were worth almost three times what they were at the end of 2020, according to PitchBook’s IPO Performance Index.

By all accounts, 2020 was marked by large fundraising initiatives for tech, as people communicated almost exclusively online at home. Then, 2021 was expected to witness a sector-wide slowdown, but the rise of what PitchBook calls “tourist investors” contributed to nearly 77 percent of all venture flow. Unlike venture capital funds, which exclusively focus on high-risk/high-reward startup investments, these non-traditional tourists are institutional investment firms, such as private equity, hedge funds, corporate venture arms or pension funds. Traditionally, they have a more diversified risk portfolio and have either stayed away from tech or allocated it into the high-risk section.

The impact of these tourist investors, who tend to invest in later-stage companies in higher sums, is reflected in deal count comparisons versus dollars raised: while deal count increased by 40 percent, jumping from 12,173 deals in 2020 to 17,054 deals in 2021, there was a 98 percent surge in dollars raised. It is estimated that non-traditional funds collectively have $350 billion to invest in tech, while venture-only firms have $221 billion. In 2021, two of the largest non-traditional players in early stage were Tiger Global and SoftBank. The latter historically invests in tech companies and does so particularly at later stages.

Meanwhile, Tiger Global led funding rounds for Patreon, a content creator subscription platform, Hinge Health, a healthcare startup, and Side, a real estate tech company, making a total of 335 early stage investments in 2021, more than marquee VC firm Andreessen Horowitz. Even companies with little to no tech investment history turned to the space. Related Companies, for example, invested $5 million in Revere CRE’s seed round, and $130 million in Esusu Financial’s Series B.

Why the increased interest? Because startup investment is proving less risky as an asset class. Note the performance of tech stocks to the S&P 500 in the chart linked above. If you invested $1 across a range of tech startups and $1 across a range of S&P companies in 2010, your tech investment would be worth about $12 at the end of 2021, while your S&P investment would be worth about $4. Furthermore, exits were a huge part of 2021’s story, further de-risking later-stage investments. Tech companies exited with more than $774 billion in annual exit value across IPOs, acquisitions and buyouts. Coinbase, a cryptocurrency exchange platform, generated the largest IPO fundraise, raising $85.8 billion in their first offering. The success of non-traditional investments into later-stage companies cascades down to the early stage as well.

With more money in the tech ecosystem as a whole, investors can spend more on the same equity in startups, driving up valuations. In turn, with more startups securing high valuations, other startups can valuate themselves even higher. This means they can get more capital for less equity dilution; some have secured angel or seed-stage investments worth tens of millions of dollars. While in 2010, the average early-stage company was valued at about $8.1 million, by Q3 of 2021 the average early-stage company earned pre-money valuations of $138 million, according to PitchBook.

In other words, early companies were estimated to be worth around $138 million by investors in 2021, often before having a product, revenue or profitability.

Betting millions on companies that do not have products yet is often how the system of tech investment works, and most of the time, it works well. The faith, conviction and risk-taking capacity of the investors have resulted in vital technology which we use to operate our everyday lives. Still, looking at the valuation levels of 2021, it is important to ask: are these valuations a reflection of the companies’ future values, or of a market flush with capital?

Scott Lenet, President and Co-Founder of Touchdown Ventures, wrote that early-stage valuations are irrelevant anyway: “For a venture capitalist, it doesn’t matter if a startup has an intrinsic value of zero today, if there’s a reasonable chance to make 10 times our money or better.”

According to Lenet, “It’s the potential multiple that matters, not whether we can apply traditional finance metrics to a startup,” arguing that the “art”of VC valuations is a “forgery”.

Nonetheless, the dramatic valuations and early 2022 tech stock downturn are not unlike what led to earlier bubble markets, such as the dotcom bubble in the early 2000s. “2022 has ushered in some potential headwinds for the industry,” says Alex Warfel, a Quantitative Research Analyst at PitchBook. “Equity markets are down, inflation remains a prominent theme and geopolitical turmoil are all contributing to uncertainty. The venture industry may be able to weather these difficulties on the back of sheer enthusiasm for the asset class, but there is certainly reason to doubt that the highs of 2021 can be matched or exceeded this year.”

“I think money will continue to go into startups,” says Kunal Mehta, President and Co-Founder of Cold Start Ventures, a New York-based venture firm.

“I think it will be a correction in terms of multiples that people are willing to pay for specific industries, particularly in the later stages.” But even in early stages, the valuation is less relevant than the risk, in accordance with Lenet’s sentiment. Also, the risk is declining. While tech is definitely still a very risky asset class, says Mehta, there are more groups that are spending time de-risking it, as venture firms themselves are building out their own platform functions while providing their portfolio companies with experienced legal teams, go-to market teams, marketing teams and more.

He notes that it is a lot cheaper to start a tech company now than during the dotcom boom. “That risk of two people sitting in their living room with an idea, trying to launch a startup and then raise funding for it, isn’t there as much today as it was in 2001,” Mehta says. “We have the right operations in place.Those longer term investors that are really smart and kind of strategic about this entire thing are looking at it like, ‘Alright, this is a horizon of seven to 10 years. So, despite what’s happening in the public markets, we believe that there will be valuable companies that are getting started today.’ They need to have a long-term perspective despite market fluctuations, interest rates, inflation and because they just need to blend their funds.”