Over the past decade, many venture capitalists have built vast personal fortunes. Some of the money was made through investments in companies that outperformed. But much of their wealth is due to management fees that have piled up rapidly as the size of the funds – growing faster than ever in history – reached unprecedented levels.
Given that the market has changed – and will likely remain a more challenging environment for everyone for at least a year or two – an obvious question is what is happening now. Will industry sponsors – “the money behind the money” – demand better terms from their venture managers, just as VCs currently demand better terms from their founders?
If ever there was a time for institutions that fund VCs to use their leverage and push back – on how quickly funds are raised, or the lack of industry diversity, or the hurdles that must be achieved before the profits can be split – now would apparently be the time. Yet in many conversations with LPs this week, the message to this editor was the same. LPs are not interested in rocking the boat and jeopardizing their allocation in so-called top funds after years of strong returns.
Nor are they likely to place demands on underperforming managers and emerging managers. Why not? Because there is less money for everyone, they suggest. “Markets like these exacerbate the divide between haves and have-nots,” one LP observed. “When we add someone to our relationship list,” added another, “we expect it to be for at least two funds, but that doesn’t mean we can live up to those expectations if the markets are really tough.”
Some might find the comments frustrating, especially after so much talk in recent years about leveling the playing field by putting more investment capital into the hands of women and other underrepresented people in the industry. capital risk. Highlighting the LP’s precarious relationship with the VC, neither wanted to speak on the record.
What if they had more spine? And if they could tell managers exactly what they think without fear of reprisal? Here are half a dozen gripes VCs might hear, based on our conversations with a handful of institutional investors, from the CEO of a large financial institution to a smaller fund-of-funds manager. Among the things they would like to change, if they had a say:
Weird terms. According to one sponsor, in recent years so-called “time and attention” standards – wording in sponsor agreements aimed at ensuring that “key” people will devote substantially all of their business time to the funds that they rise – began to appear. less and less frequently before disappearing almost completely. Part of the problem is that an increasing number of general partners were not focusing all their attention on their funds; they had, and continue to have, other day jobs. “Basically,” this LP says, “GPs were saying, ‘Give us some money and don’t ask questions. “”
Disappearance of advisory councils. One backer says these have largely been phased out in recent years, particularly with regard to smaller funds, and this is a worrying development. These board members “always play a role in conflicts of interest,” observes the LP, “including [enforcing] provisions that have to do with governance”, and which could have better addressed “people who took aggressive positions that were sloppy from the LP’s point of view”.
Lightning fast fundraising. Many LPs received routine distributions in recent years, but their portfolio managers were asking them to commit to new funds almost as quickly. Indeed, as VCs compressed these fundraising cycles – instead of every four years, they returned to LPs every 18 months and sometimes faster for new fundraising commitments – it created a lack of temporal diversity. for their investors. “You invest these small slices in dynamic markets and it stinks,” says one manager, “because there’s no diversification in the price environment. Some VCs have invested their entire fund in the second half of 2020 and the first half of 2021 and it’s like, ‘Damn, I wonder how it’s going to be?’
Bad attitudes. According to several LPs, a lot of arrogance has crept into the equation. (“Certain [general partners] would be like: take it or leave it. LPs argue that there’s a lot to be said for a measured pace to get things done, and that as the pace has gone, so too has the mutual respect gone in some cases.
Opportunity Fund. Boy do LPs hate opportunity funds! First, they view these vehicles — intended to support a fund manager’s “small group” portfolio companies — as a sneaky way for a VC to circumvent their fund’s supposed size discipline. A bigger issue is the “inherent conflict” with opportunity funds, as one LP describes it. Consider that as an LP, his institution may have a stake in the main fund of a company and another type of security in the same company in the opportunity fund which may be in direct opposition to this first stake. (Let’s say her outfit is offered preferred stock in the Opportunity Fund while her stock in the Startup Fund is converted to common stock or otherwise “pushed down the preference pile.”)
LPs we spoke with this week also said they resent being forced to invest in VC opportunity funds in order to access their seed money, which apparently happens a lot. in the last two years in particular.
Be invited to support other venture capital firm vehicles. Many companies have rolled out new strategies that are global in nature or see them pouring more money into the public market. But, surprise, LPs don’t like spreading (it makes it harder to diversify their own portfolios). They also became uncomfortable with the expectation that they were playing with this mission creep. Says an LP who is very happy with his assignment at one of the world’s most important venture capital groups, but who has also become disillusioned with the company’s new areas of focus: “They’ve earned the right to do a lot of things that they’re doing, but there’s a feeling that you can’t just pick the VC fund; they’d like you to support multiple funds.
The LP said they would get along. The venture capitalist told him that if his ancillary strategies weren’t suitable, they wouldn’t count the decision as a strike against his institution, but he’s not quite buying it, no pun intended.
So what happens in a world where LPs are afraid to put their figurative foot down? It largely depends on the market. If things bounce back, you can probably expect the LPs to continue to cooperate, even if they grumble privately. In a sustained downturn, however, the sponsors who fund the venture capital industry might become less timid over time. May be.
At least, in a separate chat earlier this week with veteran VC Peter Wagner, Wagner observed that following the dot.com crash of 2000, a number of venture capitalists let their LPs go. gain by reducing the size of their funds. Accel, where Wagner spent many years as a general partner, was one such outfit.
Wagner doubts the same is happening now. While Accel focused narrowly on early-stage investments back then, Accel and many other influential players now oversee multiple funds and multiple strategies. They will find a way to use all the capital they have raised.
Still, if the returns don’t hold up, LPs might run out of patience, Wagner suggested. Generally speaking, he said that “it takes a number of years to play out” and that in a few years, “we could be in a different situation [better] economic environment.” Perhaps the moment of pushback will have passed, in short. If not, however, if the current market drags on as it is, he said, “I wouldn’t be not at all surprised if [more favorable LP terms] were in discussion within a year or two. I think it could happen.