Over the last decade, many venture capitalists have built large personal fortunes. Some of the money has been raised through investments in companies that have outperformed. But much of his wealth can be traced to management fees that quickly added up as fund sizes, raised in faster succession than ever in history, skyrocketed to unprecedented levels.
Given that the market has changed, and will likely continue to be a tougher environment for everyone for at least a year or two, an obvious question is what happens now? Will the industry’s limited partners, the “money behind the money,” demand better terms from their venture managers, just as venture capitalists are right now? better conditions of its founders?
If there was ever a time for institutions funding VCs to use their leverage and back off, about how quickly funds are raised, or the industry’s lack of diversity, or the hurdles that need to be overcome before they can split earnings now apparently would be time. However, in numerous conversations with LP this week, the message to this publisher was the same. LPs aren’t interested in rocking the boat and risking their allocation in so-called blue-chip funds after years of strong returns.
Nor are they likely to put pressure on emerging and underperforming managers. Why not? Because there is less money for everyone, they suggest. “Markets like these exacerbate the divide between haves and have-nots,” observed one LP. “When we add someone to our list of relationships,” another added, “we expect it to be for at least two funds, but that doesn’t mean we can meet those expectations if the markets are really tough.”
Some may find the comments frustrating, particularly after so much talk in recent years about leveling the playing field by putting more investment capital in the hands of women and others who are underrepresented in the venture industry. Underscoring the LPs’ precarious relationship with venture capitalists, neither wanted to speak officially.
But what if they had more backbone? what if they might Tell managers exactly what you think without fear of retaliation? Here are half a dozen complaints VCs may hear, based on our conversations with a handful of institutional investors, from a managing director at a major financial institution to a smaller fund-of-funds manager. Among the things they would like to change, if they had their preferences:
Strange terms. According to one limited partner, in recent years, so-called “time and attention” standards (language in limited partner agreements intended to ensure that “key” people devote substantially all of their trading time to the fund they are raising) began to appear. ). less and less frequently before disappearing almost completely. Part of the problem is that a growing number of general partners they were not focusing all your attention on your funds; they had, and continue to have, other day jobs. “Basically,” this LP says, “GPs were like, ‘Give us money and don’t ask questions.'”
Disappearance of advisory councils. One limited partner says these have largely fallen by the wayside in recent years, particularly when it comes to smaller funds, and that it’s a disturbing development. Such board members “still play a role in conflicts of interest,” the LP observes, “including [enforcing] provisions that have to do with governance”, and that could have better addressed “people who were taking aggressive positions that were neglected from an LP perspective”.
Hyper fast fundraising. Many LPs were receiving routine distributions in recent years, but their portfolio managers were asking them to commit new funds almost as quickly. In fact, as VCs compressed these fundraising cycles (instead of every four years, they reverted to LPs every 18 months, and sometimes faster for new funding commitments), it created a lack of diversity of time for its investors. “You’re investing these little bits in momentum markets and it just sucks,” says one manager, “because there’s no diversification of the pricing environment. Some venture capitalists invested their entire fund in the second half of 2020 and the first half of 2021 and they’re like, ‘Gee, I wonder how that’s going to turn out’.”
Bad attitudes. According to various LPs, a lot of swagger crept into the equation. (“Certain [general partners] It would be like: take it or leave it”). The LPs argue that there’s a lot to be said for a measured pace of getting things done, and that just as pacing went out the window, so too did mutual respect in some cases.
Opportunity funds. Boy, LPs hate opportunity funds! First, they view such vehicles, intended to support a fund manager’s “defunct” portfolio companies, as a sneaky way for a VC to navigate around their supposed fund size discipline. A bigger problem is the “inherent conflict” with opportunity funds, as one LP describes it. Consider that, as an LP, your institution may have a holding in a company’s main fund and a different type of security in the same company in the opportunity fund that may be in direct opposition to that first holding. (Let’s say your team is offered preferred shares in the opportunity pool, while your shares in the early-stage fund are converted to common stock, or otherwise “rolled down the preference stack.”)
The LPs we spoke to this week also said they resented being forced to invest in VC opportunity funds to access their early-stage funds, which apparently was happening a lot in the past couple of years in particular.
Being requested to support other vehicles of venture companies. Numerous companies have launched new strategies that are global in nature or see them investing more money in the public market. But, surprise, LPs don’t like expansion (it makes diversifying their own portfolios more difficult). They have also been uncomfortable with the expectation of playing along with this strange mission. Says an LP who is very happy with his assignment to one of the world’s top venture teams, but who has also grown disillusioned with the company’s new areas of focus: “They’ve earned the right to do a lot of the things What do they do”. is doing, but there is a feeling that the risk fund cannot be chosen; they would like me to support various funds.”
The LP said that he goes to get along. The venture firm told him that if his ancillary strategies didn’t mesh, he wouldn’t view the decision as an attack on his institution, but he doesn’t entirely believe that, no pun intended.
So what happens in a world where LPs are afraid to put their figurative foot down? It depends on the market to a large extent. If things pick up, you can probably expect the LPs to continue to cooperate, even if they complain in private. However, in a sustained downturn, the limited partners funding the venture industry could become less timid over time. Maybe.
At least in a separate conversation earlier this week with veteran VC Peter Wagner, Wagner noted that after the dot-com crash in 2000, several venture firms freed up their LPs by reducing the size of their funds. Accel, where Wagner spent many years as general partner, was among these teams.
Wagner doubts the same will happen now. While Accel was strictly focused on early-stage investments at the time, Accel and many other power players today oversee multiple funds and multiple strategies. They’re going to find a way to use all the capital they’ve raised.
Still, if the gains don’t hold up, LPs could run out of patience, Wagner suggested. Generally speaking, he said that “it takes quite a few years to develop,” and that in a few years, “we might be in a different situation.” [better] economic environment.” Perhaps the time for the pullback is past, after all. However, if it hasn’t, if the current market continues as it is, he said, “I wouldn’t be at all surprised if [more favorable LP terms] came under discussion in the next year or two. I think that could happen.”