For emerging fund managers trying to break into venture capital, the fundraising boom of the past decade is over. During the first half of 2022, the limited partners (LPs) who fueled the surge have slowed their commitments to emerging VC managers.
According to Carta data:
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VC fundraising saw a quarter-over-quarter decline. The number of capital commitments to U.S. VC funds and special purpose vehicles (SPVs) on the Carta platform declined by 26%, and the total value of those commitments decreased by 43% when compared to Q1 2022.
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Q2 totals are sharply down from the highs of Q4 2021. The total value of capital commitments fell by 64% in Q2, compared with the peak in Q4 2021. The number of funds and SPVs recording capital commitments is down by 45% over the same interval.
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Smaller funds saw a 47% decline in commitments. Funds with less than $50M in assets under management saw a steep drop in commitments in Q2 when compared with the peak in Q4 2021. Funds with over $100M saw a less severe decline of 28% over the same time period.
As the pace of capital commitments slows, emerging VCs are changing their fundraising tactics. To generate momentum, some have opted to raise money using the 506(c) exemption, which allows them to market their funds outside their networks. Others have adjusted their strategies to bring in a more diverse set of LPs.
LPs are proceeding with caution
Despite signs pointing to a slowdown in the venture-backed economy, established firms have continued to add billions to their coffers in 2022. In May, Andreesen Horowitz announced it had raised $4.5 billion for its fourth crypto-focused fund. In July, Lightspeed Venture Partners announced more than $7 billion in commitments across three funds, topping the $4 billion Accel raised in June.
Emerging managers face a different outlook. Pensions, endowments, and other institutional LPs often try to mitigate risk by committing money to more established fund managers. In times of uncertainty, they face greater incentive to stick with managers with proven track records. Thus far, 2022 has been filled with uncertainty: The Federal Reserve has been raising interest rates to tame inflation; the war in Ukraine is upending the global economy; and supply chain pressures on the global economy remain at historically high levels.
Some investors and venture fund GPs view the fundraising downturn as a return to a more sustainable pace.
Nate Leung, an executive who oversees the fund investing business at Sapphire Partners, says the fundraising slowdown has been “palpable.” But he views the last few months as healthy for a VC ecosystem marked by elevated startup valuations that caused fundraising figures to surge throughout 2021.
“Venture fundraising cadence has absolutely slowed in 2022, though it still remains elevated relative to long-term historical averages,” Leung says. “2021 was an anomaly in so many ways and this year feels like a return to normalcy. I think venture investors—GPs and LPs alike—finally took a vacation this summer.”
Leung says some LPs have decided that the best way to deal with the current economic uncertainty is to simply wait until they have a better sense of the Fed’s plan for interest rate hikes or of how the global economy might rebound. Maria Velissaris, founder of SteelSky Ventures, agrees: “Some LP strategies take a long-term view, have patient capital, and think in decades rather than years,” she says. “Others contract, double down on existing fund managers, or halt investments entirely.”
These more cautious LP behaviors have put even more pressure on the emerging funds competing for the money LPs haven’t already allocated to VC mega-funds.
Public market volatility hits VC
Many VC firms that invested heavily in late-stage tech companies over the past few years have marked down their investments to reflect the tech-heavy NASDAQ composite, which fell more than 30% in H1. LPs might be scared off by those markdowns in future raises, especially if emerging VCs can’t point to past wins in their personal track records. But Leung doesn’t view the pullback as a tech bubble.
The good news for general partners trying to break into venture is that fundraising hasn’t shut down altogether. Sapphire has already invested with two first-time fund managers in 2022. That includes backing a former angel investor who had no previous experience in VC and allocating to a first-time manager who spun out from another firm. But Leung cautions that some struggling investors will be squeezed or shut down, with their general partners likely opting to join a bigger VC fund or take another job in tech.
“There will likely be both emerging and established VCs who don’t make it through this downcycle,” he adds. “Performance differentials are just starting to show up in venture numbers, and we expect that trend to continue throughout this year.”
Meanwhile, established VCs strengthened their relationships with LPs by posting stellar performances over the past two years, giving them an advantage over newer competitors trying to break into the industry, according to Leung.
“2021 was a banner year for exits and distributions,” he says. “It’s natural that these same firms raised new, larger funds as LPs entrust them to invest through cycles and generate attractive long-term returns. The concentration of capital in these platforms places additional pressure on the available (money) for new emerging managers.”
Emerging managers get creative
Even first-time fund managers that had overwhelming interest from LPs in 2021 have experienced a rocky fundraising environment in 2022.
360 Venture Collective managing partner Kelly O’Connell initially wanted to raise $10 million for the Miami firm’s debut fund to make investments in under-represented founders in the tech space. “There is less money right now being allocated to those startup founders,” O’Connell says. “That needs to be rectified.”
Late last year, the firm raised the target fund size to $25 million after receiving strong demand from LPs. But O’Connell says that 360 Venture Collective’s LPs have now opted to downsize their allocations based on the uncertainty in the market, while maintaining their commitment to the fund.
“It was disheartening for a bit, but the conversations are still really positive,” O’Connell says. “[LPs] want to talk with us, but it feels like there is a lot of fear driving the market right now.”
Institutional LPs, in particular, have responded to the uncertainty by allocating more money to established VCs to help them shore up their portfolios.
“Our institutional LPs, our largest checks that were supposed to be coming into our funds, are the ones that have hit the pause button on the transfer, but they’re still having conversations with us,” she says.
360 Venture Collective has persevered, making six investments and holding a first close on its debut fund earlier this year. The firm has also started hosting webinars, and plans to increase public speaking appearances to entice more investors to join its debut fund, with a second close planned for October 2022.
O’Connell says she’s grateful the firm raised money under the 506(c) exemption, which permits GPs to recruit LPs outside of their personal and professional networks, including through public solicitation and advertising. She believes the 506(c) exemption has improved her firm’s ability to bring in a more diverse set of LPs to champion the underrepresented founders leading their portfolio companies.
Rule 506(c) was created in part to support emerging managers, who face more fundraising challenges than established VCs. Most are often just beginning their careers in the industry and lack the same robust personal networks of investors that more seasoned GPs have. Others may come from backgrounds that make it less likely for them to have large personal networks of accredited investors among their friends, family, and former classmates. In part to help emerging managers find more potential investors in their own networks, the SEC’s Small Business Forum recently advocated for changes to broaden investor accreditation.
But for many general partners, it’s been difficult to convince investors to make commitments when the IPO market is largely frozen, dealmaking has slowed, and some still view tech valuations as elevated.
“As an emerging fund manager, it can be a challenge to raise capital in both bull and bear markets,” SteelSky Ventures’ Velissaris says. “The additional uncertainty around the macro environment further exacerbates an already-difficult undertaking.”
Some see an advantage in the slowdown
Civilization Ventures founder Shahram Seyedin-Noor agrees the fundraising environment has slowed down this year, but he believes it will benefit his firm. A flight to “quality” by LPs during a funding pullback, he says, will benefit funds that have already seen significant results. To date, Civilization Ventures has invested in four biotech companies that have surpassed $1B valuations.
“The reality is: They just invested in crazy valuations,” Seyedin-Noor says of struggling VCs. “And they’ve all taken a ridiculous bath. And so those funds look terrible.”
Despite the rocky short-term outlook, Sapphire Partners’ Nate Leung remains hopeful for a fundraising turnaround. Numerous industries are going through a digital transformation that will require more investment. And his firm is still actively looking for opportunities to back the next promising VC.
“Emerging managers are still actively in market raising funds and investing,” he says. “We continue to be excited to back emerging managers and first-time funds whether they are spinning out from larger platforms or new to managing institutional capital.”
An early look at Q3 VC fundraising on Carta suggests his optimism might not be unfounded: Data from July 2022 shows that the decline has slowed. As of August 8, 2022, the value of capital commitments recorded on Carta for July is down 11% from June—but as funds catch up in reporting, this gap will continue to narrow. Still, it’s unclear if the decline in capital commitments has bottomed out, how long it will take for the pace of commitments to begin to increase, or when we’ll return to 2021 levels of funding.
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About the data: Most of the 888 firms using Carta’s fund administration services as of August 8, 2022 are emerging managers. The median fund entity size in this data set (which includes SPVs) is roughly $5 million, and half of the almost 2,800 funds range from $1.3M to $20M. Carta launched its fund admin business for VC in 2018.
