The fall of WeWork was a jolt to venture capital—how that could change VC investing

2019 was a banner year for venture capital, but the WeWork crisis may make VC investors more wary. Here's what to expect in 2020.

When news broke in September that SoftBank-backed WeWork was pulling its doomed IPO, a chill ran across the capital markets.

Mere days before, entertainment and talent agency Endeavor had also pulled its IPO. In December, following disappointing growth, SoftBank sold back its nearly 50% stake in late-stage dog-walking startup Wag Labs to the company. And according to reports, pizza startup Zume was in talks with SoftBank to raise another funding round in late 2019, but the deal fell apart in December (the company subsequently laid off hundreds of workers in January).

As the investor world grappled with the failure of some of SoftBank’s most lavishly-funded startups, a renewed sense of scrutiny started taking hold for some investors. Barrett Cohn, the co-founder and CEO of private market investment bank Scenic Advisement, sees that trend continuing. As he puts it, investors will be “scrutinizing the companies much more heavily.”

“Flashing yellow caution sign”

On the whole, 2019 was a banner year for venture funding. But while the deal count in late-stage venture capital hit records in 2019 at nearly 2,600 (with over $85 billion invested), the 4th quarter of 2019 saw a slight slump, failing to crack 600 deals for the quarter (back down to pre-2019 levels), according to PitchBook data. (Although historically the 4th quarter is one of the slowest for late-stage deal activity, according to PitchBook).

Those like Cohn believe that SoftBank’s missteps gave investors pause. But SoftBank’s strategy “was so vastly unique” and “anomalous,” Cohn says, that, on the whole, private investors have been (and will continue being) judicious. Still, with the heightened awareness of ever-rising private valuations and ever-maturing private companies, he says the overriding message for private investors this year is “a flashing yellow caution sign.”

That doesn’t mean deal flow will grind to a halt. There are still plenty of analysts and VC firms alike betting that the flow of capital into the private markets will continue largely unchanged—even at the late stages.

The amount of capital raised in venture last year missed 2018’s record. But the $46.3 billion raised as of the end of the 4th quarter for U.S. venture funds, according to PitchBook data, was nothing to dismiss. Those closest to the money aren’t seeing venture capital soar or sink in 2020—even despite the highly publicized struggles of SoftBank’s disastrous late-stage ventures.

What’s driving the momentum for investments into venture is the amount of capital available to companies, fueled by record amounts of cash being distributed back to LPs (limited partners) that will likely be recycled back.

Judicious venture investing

If the WeWork debacle and the poor public debuts of companies like Uber, Lyft, and SmileDirectClub taught us anything it’s that the public markets are going to be tougher on high-flying unicorns. That’s not a bad thing, market observers note.

“The private markets have found religion, so to speak. Now they know that growth at any cost is not acceptable anymore,” says Santosh Rao, head of research at Manhattan Venture Partners. “There is money out there that needs to be [put to work], but the VCs are going to be much more prudent and rational in terms of funding these companies.”

For Scenic’s Cohn, that means, “we’re back to basics.” Companies with “great fundamentals, real unit economics, and a proper mote around them” are going to win late-stage rounds this year.

In 2020, analysts are predicting that VC funding will continue to see strong investment, both in early and late stage rounds—as plenty of money is earmarked to be recycled into late-stage mega U.S. deals and at the pre-money seed level, likely pushing median seed-stage valuations up higher, according to PitchBook’s 2020 Venture Capital Outlook. Even traditional early-stage investors are angling later in funding rounds—which is true of Peter Thiel’s Founders Fund, breaking with its usual formula with it latest $1.5 billion fund, focused primarily on growth-stage startups rather than seed-stage startups.

In fact, Shaw has been seeing a trend emerge of early-stage seed and Series A venture capital funds creating so-called “follow-on funds,” designed to give early venture investors an opportunity to continue investing in their best companies at later funding rounds (like Series B and C). Shaw suggests this trend is likely to continue in 2020 and beyond as investors aren’t shying away from later stage investments to keep from diluting their stake.

But that’s not to say some sectors won’t find it hard to raise capital. Micro mobility and cannabis startups are two that come to mind for Cohn. The poor share performance of public companies like Aurora Cannabis in 2019 are a “harbinger for the other companies in the space.”

Exit opportunities: the 2020 IPO pipeline is filling up

Last year, private investors got a record-breaking bang for their buck as VC exit value topped $250 billion. Almost 80% of those came from VC-backed IPOs, according to PitchBook. That momentum looks likely to continue this year.

An IPO pipeline, chock full of big names like Airbnb, Casper, and Robinhood, is likely to bring public markets another big year. “I think the appetite [for IPOs] will be there, but investors aren’t going in blindfolded looking at these companies—I think those days are over,” says Kathleen Smith, principal at Renaissance Capital, a provider of institutional research and IPO ETFs.

Still, in a post-WeWork world, some companies may be postponing the IPO in favor of taking on more private capital or pursuing M&As. Several companies yanked or postponed IPOs late last year, including Endeavor (who had already filed) and others like Postmates and Robinhood, who had been rumored (but not filed) to go public.

In fact, according to data from Renaissance Capital, only one U.S. VC-backed tech IPO went public in the 4th quarter—Bill.com. Plaid, for one, followed the M&A path as Visa announced a $5.3 billion acquisition of the fintech this month.

“We have to point back to SoftBank,” Scenic’s Cohn says. “SoftBank had a strategy of putting huge checks into one company to create the hegemon, and that largely didn’t work, and they did it very publicly and it freaked out the investor universe.”

Instead, Cohn suggests we might see companies staying private indefinitely, opting to pick up larger rounds of private capital or use M&A to build bigger private companies away from the public’s watchful eye.

But even with the record amounts of capital in private markets, Cohn is seeing even more “dry powder,” or unspent capital, “just coming online.”

That too should boost deal flow.

More must-read stories from Fortune:

—Forget policymakers. Greta Thunberg and her allies are targeting CEOs

—Investors see a 2020 recession coming—but think they’ll make money

—The Carlos Ghosn affair: A look inside the motivations of a fugitive CEO

—What $1,000 in 10 top stocks a decade ago would be worth today

—Laws meant to close down tax havens and shut loopholes could have opposite effect
Subscribe to Fortune’s Bull Sheet for no-nonsense finance news and analysis daily.