The amount of capital LPs are being asked for to meet their commitments to venture funds now exceeds the amount they are seeing back on investments. The ratio between the two peaked at 4.5 times at North American venture firms in 4Q 2023. Returns on venture investments in initial public offerings or sales of startups have been so light that outside investors are no longer getting enough to sink new money into venture funds. LPs are straining to meet cash obligations to fund managers who then have trouble raising their next fund. “The money is not making the round trip.” The liquidity crunch at LPs is even greater than after the 2000 dot-com crash. In the first half of this year, 255 venture funds closed in the U.S. At that rate, 2024 will be the year with fewest fund closes in a decade.The normal recycling of money through the venture capital ecosystem has dammed up like never before.
Returns on venture investments—in the form of initial public offerings or sales of startups—have been so light that outside investors, or limited partners, are no longer getting enough from those bets to sink new money into venture funds. LPs, which make commitments to venture funds, are straining to meet their cash obligations to fund managers—who then have trouble raising their next fund.
“The money is not making the round trip,” said Marc Cadieux, president of Silicon Valley Bank. “That is impacting investors’ willingness and appetite for the venture asset class.”
The amount of capital LPs are being asked for to meet their commitments to venture funds now exceeds the amount they are seeing back on investments. The ratio between the two reached a peak of 4.5 times at North American venture firms at the end of 2023—up from parity the year previous, according to a report by Silicon Valley Bank, a division of First Citizens Bank. According to the data, the liquidity crunch at LPs is even greater than after the 2000 dot-com crash. LPs include family offices, foundations, pension funds and others that invest in venture funds.
“The liquidity issue is real, as limited partners are at least partially dependent on incoming liquidity to satisfy capital calls,” Samir Kaji, chief executive and co-founder of Allocate, referring to the capital LPs are committed to providing venture funds.
Tougher to Raise New Funds
The IPO market, one of the main avenues for investors to see their bets pay off, has ground to a near halt. Meaningful acquisitions of startups have also become rare, in part due to regulator scrutiny and antitrust concerns.
The freeze is being felt in several ways. First off, it is making it harder for venture fund managers to raise new funds.
In the first half of this year, just 255 venture funds closed in the U.S., according to the PitchBook-NVCA Venture Monitor. At that rate, 2024 will be the year with fewest fund closes in a decade.
“Outside of perhaps 10% of the [general partners], GPs are taking much longer to raise, we’ve seen some reduction in fund targets, and others have totally left the space,” said Kaji, using the industry term for venture firms.
Some venture investors who might have struck out on their own are deciding against it in today’s market. Maria Palma, general partner at Freestyle Capital, for example, said she had considered raising her own venture fund earlier this year after leaving a job at Kindred Capital.
“I wanted to raise $100 million and lead rounds. I could’ve gotten it done, but it would’ve taken three years,” she said of the slog to raise that much money in the current environment. Instead, she joined Freestyle.
The lack of returns on investment is also driving LPs to concentrate on just a few fund managers, exacerbating a haves and have-nots dynamic in venture. Several stalwarts of the venture world, like Andreessen Horowitz and Thrive Capital, raised mega funds this year, as the rest of the market struggled.
A Busier Secondary Market
Another result of the skimpy payoffs is a larger secondary market, where venture-fund managers, their investors and others sell stakes in startups and venture portfolios.
“Since the last time there was a downturn, the secondary market is much bigger and a ready source of capital,” said SVB’s Cadieux.
Indeed, secondary sales of stakes in venture funds and venture-backed companies could total between $105 billion and $130 billion, getting back to the lofty levels of 2021, according to Hans Swildens, chief executive and founder of Industry Ventures. The firm has raised $2.6 billion in new funds, mostly dedicated to venture secondaries, since last year.
“LPs that are not able to keep funding their LP commitments are selling them to secondary funds or existing LPs in the venture partnerships,” Swildens said, pointing to one source of secondary business.
Venture firm Group 11 has arranged sales of stakes in its funds for current investors to new ones, including StepStone Group and Industry Ventures, with a total $96 million changing hands in the past two years.
“You get new reputable, institutional, large investors in, and you get investors who are tired out,” said Dovi Frances, general partner at Group 11. The sellers, he said, were mostly high-net-worth individuals who had been with the firm for years.
“It takes a longer time to exit and not all people have the patience. And they forget the compounded nature of exponential growth,” Frances said.
Less Help for Startups
The meager returns are also being felt at startups. Venture managers aren’t sure when it will make sense to raise funds again, and are reluctant to lean too heavily on strapped LPs.
“They are worried about what LPs are telling them they are going through. That does affect the rate at which companies are going to raise,” said Aakar Vachhani, managing partner at Fairview Capital, a fund-of-funds that backs venture managers.
Venture funds that began investing in 2022, for example, have been slowest to put money to work, according to a report by Carta. These funds had deployed 43% of their capital in their first 24 months, while funds in the prior three years had spent half or more of their cash by the same point in their life cycle.
At present, signs of any thawing in IPOs or sales are scant.
“Distribution activity has started to trickle back up,” Vachhani said of Fairview’s funds. In recent months, the firm has seen some cash from IPOs that took place a couple of years ago, as well as a slight increase in acquisitions of startups, he said. (Distributions from public listings in venture can take a while to reach LP pocketbooks.)
Interest-rate cuts on the horizon, as well as a new presidential administration, might also juice returns, SVB’s Cadieux said.
“We’ll see what happens next to get things unstuck,” he said.
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