Historically high levels of venture capital are still being raised by fund managers, but the number of them doing so is starting to fall…
Despite the valuation bubble bursting in parts of the venture capital market, the amount of capital raised by funds during the first half of 2022 has continued to boom, driven by record numbers of follow-on funds in the US and funds closing at more than $1 billion.
In July, Bay Area-based Lightspeed Ventures said it raised more than $7 billion across three new US funds, and one focused on India. A few days later, London-based Index Ventures announced close on three funds totaling $3.1 billion. Andreessen Horowitz and New Enterprise Associates have also announced fund closes above $2 billion already this year.
“We’ve seen VC firms, especially in top five or top 10, invest heavily in their IR teams [to hit record fundraising levels]. This is a natural evolution for VC as the menu for investors expands across the private markets,” says Miguel Luina, head of global venture and growth equity at investment manager Hamilton Lane.
At 2022’s current rate of fundraising – $112 billion up to June 30, according to Preqin – this year’s total would eclipse the previous record of $210 billion raised in 2021. This is unlikely to be the case, however.
A survey by Private Equity Wire during July found that 85% of respondents believe the industry is in a “more challenging” fundraising environment than a year earlier.
In Q2, global VC fundraising was down year-on-year and the number of funds closed was the lowest seen in the past five years once the Covid-19 panic months of Q2 2020 are excluded.
With only 560 fund closes in H1, even if the same number return during the second half of the year, the 2022 total would be a staggering fall from last year’s peak of 1,790 funds closing.
There are two possible explanations for this.
Firstly, the new entrants or ‘crossover funds’ – hedge funds, institutions and corporates – drawn into late-stage venture in hope of cashing out quickly during the boom are retrenching (see box page 6).
There is also a second reason, which is impacting private markets more generally: LP investors are pulling back on commitments as the value of their VC investments appears overweight, relative to a lower valued stock market, known as the denominator effect.
Around $33 billion worth of stakes in private funds were sold during the first six months of the year, up from $19 billion in the same period in 2021, according to investment bank Jefferies, with almost half of these involving a first-time seller. Stakes in venture capital funds were sold at an average 71% of their most recent valuation.
A recent survey by Preqin found that a third of institutional investors plan to cut their exposure to VC over the coming 12 months, compared to only 13% last year.
With VC valuations still somewhat elevated (see Chapter 4), the denominator effect will force more LPs to continue tweaking their allocations through 2022 and possibly until early 2023, say sources.
Further slowdown
“The VC fundraising market hasn’t really been tested yet,” says Luina at Hamilton Lane. “I think Q1 2023 is when you will see the ‘new normal’. Performance is still really strong, but a further slowdown is expected.”
“The denominator effect is real,” says Ophir Shmuel, managing director at fund placement agent Eaton Partners. “We saw it during the global financial crisis and we’re seeing it now, especially in VC where valuations have been quite lofty. Macroeconomic factors are also playing a part and LPs are being more weary and conservative [about their commitments].”
The recent public market correction is unlike the financial crisis or the V-shaped Covid recovery, however.
In a presentation by VC giant Sequoia Capital to founders in May, the company described a “crucible moment” with a long economic recovery and massive implications for fundraising. At the same time, Sequoia is reported to be raising two new US funds totalling more than $2 billion, alongside closing almost $9 billion for Chinese VC. So, what gives?
Given VC is typically only a small percentage of an LP’s overall portfolio, wild swings in allocations are not expected. Established fund managers may also seize the opportunity to “steal market share” from LPs still active, says Stephanie Choo, partner at Portage Ventures, who notes a pullback from family offices, many of whom can be more flexible in their allocations.
Large allocations of VC capital are still out there. In April, the $190 billion Ontario Teachers’ Pension Plan Board said it plans to more than double the size of its venture portfolio from 3% of net assets to 7-10% over the next five to 10 years.
“This will set a precedent,” says Ed Knight, president at VC firm Antler, “bigger pools of capital are coming in and longer-term allocations I think are going to remain very, very positive.”
Public pension funds outside the US may be another pool.
In US VC, public pension funds contribute 65% of the capital but the figure is only 18% in Europe and 12% in the UK, according to 2020 figures. In Ireland, where the figure is less than 1%, an industry body has called on government to help scale up domestic VC pension contributions.
Where does this leave VC in H2 2022?
VCs in fundraising mode remain optimistic, dependent on their strategy. Washington DC-based venture fund Starbridge recently launched a $125 million fundraising process for its third fund, targeting first close in September and final close in summer 2023.
“The markets are down and everyone’s turtling,” says Michael Mealling, a general partner at the fund, “especially people who have not experienced a normal recession. I see many people whose only experience of a down market was the 2008 financial crisis and they’re equating it with now. [The current correction] is not a structural problem with the financial system and some of them are starting to realise that. So in terms of LPs, we really do expect and are already starting to see some green shoots beginning to come through.”
As a specialist fund targeting space-technology, which also tends to be less exposed to economic cycles, Starbridge Fund III should still appeal to LPs in the current climate, he adds.
Another LP priority can also be predicted. “There is a focus now [from LPs] on less cyclical funds; also for more niche and differentiated strategies – whether that be AI or cyber or deep tech, where there is less competition with everyone else,” says Shmuel.
With late-stage VC valuations typically the first to be hit by a public market correction (see Chapter 4), there may also be an opportunity for fund managers to provide strategic solutions here, as others exit or look to early-stage investment.
Portage – a well-known fintech VC fund – recently reached first close on a new opportunistic late-stage fund, making it able to step in where others have pulled back.
“We could not have picked better timing,” says Stephanie Choo, at Portage. “LPs see the need for this type of capital solution now and it requires a specific skill set.”
For more generalist VC managers in the middle of fundraising, patience is advised.
“Unless you are a top-tier fund, be prepared to take a little bit longer and be a little bit more understanding of the position LPs are in – many are now looking to 2023 allocations,” says Dan Aylott, head of European private investments at Cambridge Associates. 
