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Weekend Analysis

Threat of irrelevance looms over emerging VCs

The cards are stacked against emerging GPs in 2024, which are doing everything they can to stay in their LPs’ good graces.

Holiday jet lag isn’t the only thing keeping VCs up at night.

Countdown Capital‘s announcement last week that it is shutting down marked a rocky start to 2024 for emerging managers. Jai Malik, founder and GP of the early-stage industrial tech investment firm, wrote in a LinkedIn post that, despite strong performance, “the future of this space favors larger firms than mine.”

Emerging managers are worried: Many are giving LPs more leeway on terms and extending their fundraising time frames, and even top-tier firms are holding off on introducing premium carry. 2024 will be a year that decides which GPs turn into tenured players.

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Even VC firms that have been around for decades aren’t immune to market forces. OpenView, a Boston-based investor founded in 2006 that backed the likes of Calendly and Cogito, laid off most of its staff in December.

Most will simply fade away—not go out with a bang like OpenView and Countdown.

Emerging GPs left high and dry

For first-time fund managers, the fundraising picture hasn’t been as bleak as many predicted. In 2023, debut US VC funds raised 72% of what was raised in 2022. That’s better than US VC funds overall, which amassed just 39% of aggregate fund value from the previous year, according to the Q4 2023 PitchBook-NVCA Venture Monitor.

Part of that success is selection bias.

“Other than famous founders and people who are peeling out of really big firms, very few people have enough people who just trust them to manage money,” said Ali Hamed, co-founder and partner at asset manager CoVenture and Crossbeam VC.

Fund count data supports that conclusion: A select few very large debut funds inflated the total amount raised for first-time VCs in 2023, while the fund count for both emerging and overall VCs dropped off by more than 60%, according to Pitchbook data.

 


In 2020, a slew of LPs committed to supporting emerging managers. But that spigot has largely been cut off as many LPs flee to the perceived safety of large, tenured funds.

“On the LP side, I don’t see much appetite for much more new emerging manager investment activity,” according to Aakar Vachhani, partner at Fairview Capital, a fund-of-funds with a dedicated diverse and emerging manager investing strategy.

CalSTRS’ partnership with Sapphire Ventures to fund emerging managers, announced in September, was the exception to the rule in 2023. Compared to 2020, new emerging manager programs have come to a standstill—and those that were formed three or four years ago are focused on their existing relationships, not bringing in new blood.

Emerging managers tend to underperform established managers, PitchBook data shows. Funds from up-and-comers had a lower multiple of total value to paid-in capital, or TVPI, than established managers in eight out of the 10 years between 2013 and 2022. That being said, fund returns data is rarely made publicly available, and returns vary hugely between emerging managers.

LP pick ‘n’ mix

LPs that are still deploying capital have substantial leverage to set the terms. That includes perks like information rights, including physical copies of financial statements of portfolio companies, and rights to coinvest without paying fees or carry.

“They see a lot more under the hood than they did previously,” said Bill Sturman, a partner in Clifford Chance’s funds practice.

Sturman, who sees mostly larger institutional investors like public pension funds and asset managers, said many of his clients are declining to commit wholesale to a venture fund. He said some are even setting up pledge funds, a concept borrowed from private equity, which allows LPs to provide capital to a particular deal or pool of deals.

Will 2024 see more shutdowns?

Already, GPs are using every strategy in the book to close their funds, from fundraising extensions to side letters to, of course, secondary stake sales.

“I just got an email this morning from a GP wanting to extend their fundraise for another six months,” said Vachhani, adding that the firm had already secured several prominent LPs and needed more time only to wrap up its raise.

Even more dramatically, some fund managers on their third or fourth fund, who would typically be at the point where they’d start charging premium carry, have held off.

Total shutdowns, on the other hand, are much less common.

“Every once in a while you might see a complete shuttering, [but] it’s rare for VCs to shut down suddenly,” said Theory Ventures founder Tomasz Tunguz.

LPs invoking a contract’s key-person provision is one of a few ways that such a dramatic event can occur.

“I’d be surprised if there were tons more OpenView announcements,” Hamed said. “Most people are pretty good at finding very quiet ways to be unsuccessful and very loud ways to be successful.”


Featured image by Chloe Ladwig/PitchBook News

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