Venture Capital

VC is performing better than ever. Then why are so few first-time funds being raised?

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Venture capital’s performance has been outstanding over the last several years, and limited partners have been more eager than ever to invest in the asset class.

2020 was a record year for venture fundraising, with nearly $80 billion of fresh capital, and this year is on pace to crack $100 billion, according to the Q1 PitchBook-NVCA Venture Monitor.

But fundraising by first-time managers hasn’t been keeping pace with that growth.

Last year, only 87 managers succeeded in closing a maiden vehicle, a sharp drop from the 145 and 162 first-time US VC funds raised in 2019 and 2018, respectively, PitchBook data shows. And inaugural fundraising continues to be slow this year.
 

 

This may seem like a conundrum for an industry that for years acknowledged that emerging managers have a good chance of outperforming established ones.

While the inability to meet GPs in person during the pandemic partially explains the decline, LPs say the reduction in first-time funds is, ironically, largely a result of venture capital’s recent success.

“Existing managers are taking up a bigger portion of LPs’ VC allocation now,” said Miguel Luiña, head of global venture and growth equity for Hamilton Lane, which advises limited partners and backs mid- to late-stage venture funds. Luiña said established VC firms are raising larger funds, along with adjacent strategies such as growth funds, and many are coming back to market with subsequent vehicles at a much faster pace than in the past.

Managers used to be on a three- to four-year fundraising cycle, but that has shrunk to 18 months—and even 12 months for some funds, Luiña said.

Growth equity and VC firm Insight Partners, for example, is reportedly raising a $12 billion fund a mere year after closing its $9.5 billion 11th vehicle. Addition, a venture firm started by former Tiger Global Management partner Lee Fixel, began raising a second fund only months after closing its first vehicle on $1.3 billion.

“Institutional LPs are overrun and out of slots for VC funds,” said Lindel Eakman, a partner with Foundry Group, which manages a formal LP effort alongside its direct venture investing strategy.

Chris Douvos, a longtime LP who runs Ahoy Capital, an early-stage fund-of-funds, said that most limited partners he knows are focused on “re-ups” with existing GPs. But he also pointed to another reason why traditional LPs aren’t putting more dollars to work in the hot venture market.

Many pension plans, endowments and foundations have found themselves suddenly exceeding their target allocations for venture assets, Douvos said. But since startups have been raising capital at higher valuations, these assets in effect are growing faster than LPs’ holdings in other investment buckets like public equities or real estate.
 

 

This means that some limited partners are constrained by how much they can invest in existing VC relationships, let alone bet on new managers.

“Until these LPs go to their boards and ask for an increase to policy targets, most will be limited with what they can do,” Luiña said.

What’s more, LPs may not be as eager to commit to debut venture vehicles because most established venture funds are performing well in the current market.

Despite these challenges, there’s no shortage of managers trying to raise their first fund.

“I receive anywhere from half a dozen to a dozen new fund pitches every day,” Douvos said. “Historically, it was only one or two pitches a day.”

Some VCs who have raised inaugural vehicles benefited from having previous relationships with institutional LPs, as was the case for Addie Lerner’s Avid Ventures, which closed its $68 million debut fund in February.

Eakman of Foundry Group, whose firm invested in Avid Ventures, said individuals and family offices, rather than institutions, are increasingly a source of capital for new managers.

Venture firms and their general partners tend to also be active in new fund formation, according to Hamilton Lane’s Luiña.

Despite family offices’ interest in venture capital, they can be hard for new VCs to win over as backers, according to Michael Kim, founder of Cendana Capital, a seed-focused fund-of-funds. “They require a very warm introduction from a trusted adviser,” he said.

Kim said another option for budding managers is raising a rolling fund on AngelList.

Unlike traditional funds, rolling funds are raised continuously via a quarterly subscription to allow managers to market the fund to the public. These vehicles, which target pre-seed and seed-stage startups, have different regulatory filing requirements from traditional venture funds and are therefore not captured in PitchBook’s first-time fund data

As for traditional VC funds, Douvos said he thinks that they will start getting funded again if “massive liquidity makes its way to LPs’ portfolios.” Significant cash returns would solve the venture overallocation problem and free up funds for first-time and emerging VCs.

Despite gains from the SPAC reverse merger boom and the strongest IPO market in two decades, he said, the majority of VC fund returns are still only “on paper” and can’t yet be recycled into new funds.

Featured image by lemono/Getty Images

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