Why Venture Capital Firm Profits Are At An Historic Low

The primary issue for Venture firm profit distributions remains a lack of exit strategies, especially given the investment frenzy around AI.

The problem with AI is that most of the activity is concentrated in big tech, leaving fewer opportunities for startups in the space. Investors can make good or better money with established firms than with smaller firms. But the larger reality is that tech has matured as a sector, with all that implies for future growth, JL

Berber Jin reports in the Wall Street Journal:

Last year, U.S. venture firms returned $26 billion to their investors, the lowest amount since 2011 while U.S. venture firms invested $60 billion more than they collected. 2024 has continued the trend.  “We’ve raised a lot of money, and we’ve given very little back.” The decline is notable because the past three years have been the highest three on record for VC firm investments since 1998. Tech startups lack the allure they once had for investors, who are enjoying huge returns coming from established tech giants that have soared in value thanks to AI. Venture firms have made IPOs less necessary as they bankroll startups indefinitely. There are (now) more than 1,400 startups valued at $1 billion or more

Silicon Valley’s venture-capital firms are having an easy time finding promising startups to back. The hard part is cashing out.

Last year, U.S. venture firms returned $26 billion worth of shares back to their investors, the lowest amount since 2011, according to the data provider PitchBook. Startup investors say 2024 has continued the trend, with high levels of investment and few acquisition deals or initial public offerings. 

“We’ve raised a lot of money, and we’ve given very little back,” Thomas Laffont, co-founder of investment firm Coatue Management, said at a recent conference. “We are bleeding cash as an industry.”

Last year, U.S. venture firms invested $60 billion more than they collected, the highest such deficit in PitchBook’s 26 years of data. As a result, the investors that back VC firms, such as university endowments and pension funds, aren’t seeing the type of profits the industry has long delivered.

The decline is particularly notable because the past three years have been the highest three on record for total VC firm investments since 1998—as far back as the PitchBook data goes.

Much of that money has recently gone to artificial-intelligence startups—a white-hot space in which valuations are rising fast and companies quickly burn through cash to develop new technology. 

U.S. venture-capital distributions, contributions and net cash flow

$150 billion

100

Distributions are profits paid to investors.

50

0

50

Contributions are investments.

Net cash flow is the difference.

100

150

2000

’05

’10

’15

’20

’23

Source: PitchBook

Some venture capitalists say one hope for change is that the incoming Trump administration might loosen regulations and spur more dealmaking, in part by installing business-friendly regulators. President Biden’s Federal Trade Commission Chair Lina Khan has been a particular thorn in the side of tech dealmakers.

“Many investors are making the bet that this administration is going to take a free market approach to M&A,” said Alex Clayton, a partner at Meritech Capital. “Whether they’re right or not, time will tell.”

IPO freeze

Startups historically had to go public a few years after their founding to raise larger sums of money unavailable in the private market. Public listings were also the only way for employees to sell their shares.

But venture firms themselves have made IPOs less necessary. Many have swelled in size in recent years, allowing them to bankroll startups indefinitely while also buying out employee shares in so-called tender offers. 

Federal Trade Commission Chair Lina Khan Photo: Laura Morton for WSJ

At the same time, tech startups lack the same allure they once had for public investors, who are instead enjoying huge returns coming from established tech giants that have soared in value thanks to AI.

There are currently more than 1,400 startups valued at $1 billion or more—so-called unicorns—according to a recent presentation from Coatue. All have investors waiting to get rich.

“There are companies that are 13, 14, 15 years old. This is beyond any historic standard. And there are over a thousand of them,” said Bill Gurley, a partner at the venture firm Benchmark.

 

Even if tech IPOs returned to their historic pace, it would take more than 20 years for all of them to go public, Coatue estimated. 

After OpenAI raised a record $6.6 billion last month, valuing it at $157 billion, investors were clamoring for the startup to head toward an exit. 

“I hope and expect that the next step for OpenAI would be to go public,” said Brad Gerstner, the founder of the investment firm Altimeter, at a Seattle tech conference. His firm invested $250 million in the round. 

There are a few bright spots. The software startup ServiceTitan is planning to go public in December, according to people familiar with the matter, while Swedish fintech Klarna filed for a U.S. IPO last week. Both companies are backed by Silicon Valley venture firms. 

Acquisition standstill

Acquisitions have slowed to a near-standstill as potential buyers have been scared off after seeing increasingly aggressive regulators block recent deals.

Last December, Adobe scuttled its $20 billion acquisition of the design startup Figma after saying it didn’t see a clear path to regulatory approval. A few months later, Figma completed a tender offer that bought out early employees and investors, alleviating pressure to go public. 

 

This summer, negotiations for Google to acquire cybersecurity startup Wiz for $23 billion ended in part because of concerns about the time it would take a deal to clear regulatory hurdles, The Wall Street Journal reported. The startup recently agreed to do a tender offer for employees valuing it at $16 billion, according to people familiar with the matter.

To get around the crunch, venture firms are getting creative. Some are shopping around their startups to private-equity buyers, while others are buying out their own stakes in startups to deliver profits to their investors.

In September, Sequoia Capital bought $861 million of its own shares in payments company Stripe held by a set of funds it launched over a decade ago. This allowed investors in the older funds to earn a profit, while Sequoia is holding the shares through a newer set of funds. Sequoia first backed Stripe in 2010. 

Stripe is the third-most-valuable U.S. startup after SpaceX and OpenAI. It raised $6.5 billion last year in a round that valued it at $50 billion, allowing it to delay a widely anticipated public listing. In February, Stripe and some of its investors agreed to buy over $1 billion of shares from current and former employees.