Fundraising for venture investors has become significantly more challenging in recent times, and firms are increasingly looking for ways to differentiate themselves in order to secure commitments.
One strategy has been for firms to focus on specific sectors, with the result that specialist vehicles have accounted for a larger share of overall VC fund count in recent years—26.4% this year compared to 22.2% in 2014.
But does specializing result in better returns compared to being a generalist fund?
We’ve analyzed the performance of 1,306 VC funds with vintages between 2000 and 2020 to see if one of these types outperforms the other. For this we have used the median internal rate of return—showing the expected annualized return a fund will generate—and the total value to paid-in capital to demonstrate the multiple of capital returned to LPs compared to their initial commitments.
In terms of overall performance, the difference between the two styles is not significant. But specialist funds come out ahead in terms of TVPI.
Specialist funds tend to have a longer investment horizon, particularly in areas like biotech or deep tech, and as a result their investments appreciate significantly over time. Some startups in specialist sectors are more capital intensive earlier on in order to achieve commercialization or reach an exit point, and thus spread returns out over time.
When looking at IRR, the most recent cohort of funds—2015 to 2020—show better performance than generalist funds. Generalist funds have the benefit of diversification, which allows them to spread risk more effectively and capture opportunities across a range of sectors. This can lead to a more stable IRR if certain industries underperform, as they are not tied to a particular area.
Specialist funds are the clear winners when it comes to vehicles under $250 million both in terms of IRR and TVPI.
Smaller funds typically focus on earlier stages, and that’s where specialist funds may have an advantage. By only concentrating on one sector, these firms build up deeper knowledge and expertise which may make it easier for them to identify promising startups and assess market trends in niche areas with a higher degree of accuracy.
Specialist teams also only have to develop networks in their focus areas instead of across multiple industries, possibly leading to better deal sourcing opportunities.
For vehicles over $250 million, the most recent cohort of generalist funds have a near 5 percentage point lead over their specialist counterparts in terms of IRR, whereas before fell behind specialist vehicles.
Larger funds have more resources to dedicate to specific sectors and, as they tend to have a focus on the later stages, the same level of in-depth knowledge is less a requirement than for the early stages.
The shift to higher IRR for generalist funds could be down to the boom in venture dealmaking that really started to ramp up around 2017 and 2018. Valuations across all sectors skyrocketed, so making bets across multiple areas paid off in a way that wasn’t feasible in a more muted market.
Specialist funds have shown a slightly higher TVPI but only by a negligible amount.
The performance of a fund can depend on many things including the investment team, market conditions, risk management and the specific areas it operates in. The long-term nature of many investments sought by specialist funds would suggest that TVPI will likely be in their favor but the shift in generalists seeing higher IRR could entice more investors to their side.
However, it is important to note that the generalists’ lead in IRR has only been with the last cohort and coincides with a bull market for VC. It will be interesting to see if generalists can hold on to their position through the current downturn.
Correction: An earlier version of this article stated that the analysis was based on the performance of 1,824 VC funds. The analysis was based on the performance of 1,306 VC funds. (Oct. 26, 2023).
Featured image by leolintang/Getty Images
