These days, it’s not easy to be a limited partner who invests in venture capital firms. The “LPs” who fund VCs are confronting an asset class in flux: Funds have nearly twice the lifespan they used to, emerging managers face life-or-death fundraising challenges, and billions of dollars sit trapped in startups that may never justify their 2021 valuations.
Indeed, at a recent StrictlyVC panel in San Francisco, above the din of the boisterous crowd gathered to watch it, five prominent LPs, representing endowments, fund-of-funds, and secondaries firms managing over $100 billion combined, painted a surprising picture of venture capital’s current state, even as they see areas of opportunity emerging from the upheaval.
Perhaps the most striking revelation was that venture funds are living far longer than anyone planned for, creating a raft of problems for institutional investors.
“Conventional wisdom may have suggested 13-year-old funds,” said Adam Grosher, a director at the J. Paul Getty Trust, which manages $9.5 billion. “In our own portfolio, we have funds that are 15, 18, even 20 years old that still hold marquee assets, blue-chip assets that we would be happy to hold.” Still, the “asset class is just a lot more illiquid” than most might imagine based on the history of the industry, he said.
This extended timeline is forcing LPs to rip up and rebuild their allocation models. Lara Banks of Makena Capital, which manages $6 billion in private equity and venture capital, noted her firm now models an 18-year fund life, with the majority of capital actually returning in years 16 through 18. Meanwhile, the J. Paul Getty Trust is actively revisiting how much capital to deploy, leaning toward more conservative allocations to avoid overexposure.
The alternative is active portfolio management through secondaries, a market that has become essential infrastructure. “I think every LP and every GP should be actively engaging with the secondary market,” said Matt Hodan of Lexington Partners, one of the largest secondaries firms with $80 billion under management. “If you’re not, you’re self-selecting out of what has become a core component of the liquidity paradigm.”
The valuation disconnect (is worse than you think)
The panel didn’t sugarcoat one of the harsh truths about venture valuations, which is that there’s often a huge gap between what VCs think their portfolios are worth and what buyers will actually pay.
TechCrunch’s Marina Temkin, who moderated the panel, shared a jarring example from a recent conversation with a general partner at a venture firm: A portfolio company last valued at 20 times revenue was recently offered just 2 times revenue in the secondary market — a 90% discount.
Michael Kim, founder of Cendana Capital, which has nearly $3 billion under management focused on seed and pre-seed funds, put this into context: “When someone like Lexington comes in and puts a real look on valuations, they may be actually facing 80% markdowns on what they perceive that their winners or semi-winners were going to be,” he said, referring to the “messy middle” of venture-backed companies.
Kim described this “messy middle” as businesses that are growing at 10% to 15% with $10 million to $100 million in annual recurring revenue that had billion-dollar-plus valuations during the 2021 boom. Meanwhile, private equity buyers and public markets are pricing similar enterprise software companies at just four to six times revenue.
The rise of AI has made things worse. Companies that chose to “preserve capital and sustain through a downturn” saw their growth rates suffer while “AI has caught on and the market moved past it,” Hodan explained.
“These companies are now in this really tricky position where if they don’t adapt, they’re going to face some very serious headwinds and maybe die.”
The emerging manager desert
For new fund managers, the current fundraising environment is especially rough, observed Kelli Fontaine of Cendana Capital, underscoring her statement with a stunning statistic. “In the first half of this year, Founders Fund raised 1.7 times the amount of all emerging managers,” she said. “Established managers in total raised eight times the amount of all emerging managers.”
Why? Because institutional LPs who committed larger sums faster than ever to VCs during the go-go days of the pandemic are now seeking quality instead, concentrating their dollars with large platform funds like Founders Fund, Sequoia, and General Catalyst.
“There are many folks, many peer institutions that have been investing in venture as long as we have or longer, and they became overexposed to the asset class,” Grosher explained. “These perpetual pools of capital that they were known for, they started pulling back.”
The silver lining, according to Kim, is that the “tourist fund managers” who flooded the market in 2021 — for example, the VP at Google who decided to raise a $30 million fund because their friend did — have largely been “flushed out.”
Is venture even an asset class?
Unsurprisingly, the panel took up Roelof Botha’s recent assertion at TechCrunch Disrupt that venture isn’t really an asset class. They largely agreed, with some caveats.
“I’ve been saying for 15 years that venture is not an asset class,” Kim said. Unlike public equities, where managers cluster within one standard deviation of a target return, things are widely dispersed in venture. “The best managers significantly outperform all the other managers.”
For institutions like the J. Paul Getty Trust, that kind of dispersion has become a real headache. “It’s quite challenging to make plans around venture capital because of the dispersion of returns,” Grosher said. The solution has been exposure to platform funds that provide “some reliability and persistence of returns,” layered with an emerging manager program to generate alpha.
Banks offered a slightly different view, suggesting that venture’s role is evolving beyond just being “a little bit of salt on the portfolio.” She said, for example, that Stripe exposure in Makena’s portfolio actually serves as a hedge against Visa, since Stripe could potentially use crypto rails to disrupt Visa’s business. (In other words, Makena sees venture as a tool that can help manage disruption risk across the entire portfolio.)
Unloading shares earlier
Another theme of the panel discussion was the normalization of GPs selling into up rounds, not just at distressed prices.
“A third of our distributions last year came from secondaries, and it wasn’t from discounts,” Fontaine said. “It was from selling at premiums to the last round valuation.”
“If something is worth three times your fund, think about what it needs to do to become six times your fund,” Fontaine explained. “If you sold 20% off, how much of the fund are you going to return?”
The discussion brought to mind a conversation TechCrunch had with veteran Bay Area pre-seed investor Charles Hudson back in June, when he shared that investors in very young companies are being forced to think increasingly like private equity managers: optimizing for cash returns instead of home runs.
At the time, Hudson said one of his own LPs had asked him to run an exercise and calculate how much money Hudson would have made had he sold his shares in his portfolio companies at the A, B, and C stages instead of holding on for the ride. That analysis revealed that selling everything at the Series A stage didn’t work; the compounding effect of staying in the best companies outweighed any benefits from cutting losses early. But Series Bs were different.
“You could have a north of 3x fund if you sold everything at the B,” Hudson said. “And I’m like, ‘Well, that’s pretty good.’”
It certainly helps that the stigma around secondaries has evaporated. “Ten years ago, if you were doing a secondary, the unspoken thing was that, ‘We made a mistake,’” Kim said. “Today, secondaries are most definitely part of the toolkit.”
How to raise in this environment (despite the headwinds)
For managers attempting to raise capital, the panel offered tough love, and advice. Kim recommended that new managers “network to as many family offices” as possible, and described them as “typically more cutting edge in terms of taking a bet on a new manager.”
He also suggested pushing hard on co-investment opportunities, including offering fee-free, no-carry co-investment rights as a way to get family offices interested.
The challenge for emerging managers, per Kim, is that “it’s going to be really hard to convince a university endowment or a foundation like [the J. Paul Getty Trust] to invest in your little $50 million fund unless you’re super pedigreed — [meaning] maybe you’re a co-founder of OpenAI.”
As for manager selection, the panel was unanimous: Proprietary networks no longer exist. “Nobody has a proprietary network anymore,” Fontaine said flatly. “If you’re a legible founder, even Sequoia is going to be tracking you.”
Kim explained that Cendana indexes on three aspects instead: a manager’s access to founders, their ability to pick the right founders, and, critically, “hustle.”
“Networks and domain expertise have a shelf life,” Kim explained. “Unless you’re hustling to refresh those networks, to expand those networks, you’re going to be left behind.”
As an example, Kim pointed to one of Cendana’s fund managers, Casey Caruso of Topology Ventures. Caruso, formerly an engineer at Google, will “go live in hacker houses for weeks to get to know the founders there. She’s technical, so she’ll actually compete with them in their little hackathons. And sometimes she wins.”
He contrasted this with “some 57-year-old fund manager living in Woodside. They’re not going to have that kind of access to founders.”
As for which sectors and geographies matter, the consensus was that AI and American dynamism dominate right now, along with fund managers who are based in San Francisco or, at least, have easy access to it.
That said, the panel acknowledged traditional strength in other regions: biotech in Boston; fintech and crypto in New York; and Israel’s ecosystem “notwithstanding the current issues there,” said Kim.
Banks added that she’s confident that consumer will have a new wave. “Platform funds have kind of put that to the side, so it feels like we’re ripe for a new paradigm,” she said.
