The state of the VC market in 2023

Coming into 2020, Venture Capital was already on a popularity kick. Some big high profile wins like Google, Facebook, Airbnb, and Uber along with "software eating the world" (bonus points if you know who said that) had turned tech and VC into the sexy part of asset allocations.

When the pandemic hit, governments were terrified lockdowns would send us into a global depression, and so they gave out masses of money to companies and people — this coupled with everyone being home with less to do and lower expenses caused what's sometimes referred to as the "speculative asset bubble".

Then two things happened - (1) people threw money at "tech" (Robinhood, meme stocks, crypto, NFTs) and (2) institutions threw money at venture capital (which then threw it at tech, often pandemic-related like Zoom and Hopin but pretty much everywhere).

Then with so much more money available and the velocity of the deployment of that money going through the roof, companies were able to bring in huge sums of capital over and over again with valuations ballooning as a result (if 5-8x revenue had been standard, the new norm became 20-30x).

When prices go up, everybody who is investing on behalf of others faces significant pressure to participate, which then caused these few trends to go to extremes:

• Institutional investors were seeing their portfolio values fly so they put more money into venture. Some institutions had 90%+ return targets for VC, which is nuts (15-25% historically is top decile and above).

• Later stage players in the growth or even private equity parts of the market began to participate in the venture space. (The best example is Tiger Global, which basically started to "index" Silicon Valley by almost indiscriminately writing checks to everyone.) This obviously drove competition and pricing for deals even higher.

Responding to these two factors, VC raised bigger funds and then turned around and deployed it all IMMEDIATELY as to not miss out on deals (e.g., if a normal fund fully deploys over a 3-5+ year period, these funds were deploying 100% of commitments literally in months). The other byproduct of this is that all of the committed capital from their investors was called and locked up immediately. Usually committed capital is called slowly, and investors can manage their overall assets more conservatively. In this case it often all went out the door within a year of the commitments (this is probably particularly true in the emerging manager space).

(Note: we can dig into the inflation of later stage deal pricing sometime, but crazy liquidation prefs and the like distorted everything ever further.)

Then you know the rest of the story. The speculative bubble bursts, money in general becomes tighter, supply chains get destroyed by the pandemic, war in eastern Europe affects oil, inflation spikes hard for all of these reasons, the Fed has to raise rates to curb inflation, the cycle turns, all inflated assets get crushed, tech stocks go down 50-70%, crypto and NFTs go bye-bye, recession looms, investable capital completely goes away, etc., etc.

Now we have some real problems in venture land…

Everybody invested in these companies when things were irrationally great — at higher and higher and higher prices. Those investments are generally not worth anywhere near what they were. For example, Hopin raised hundreds of millions of dollars at eventually something like a $7B+ valuation and recently just sold for $15M (million)!

Institutional investors who had originally set 5% (as an example) allocation targets for VC, who had then pushed those allocations higher because the asset class was doing so well, all experienced what's called "the denominator effect". Their portfolios are comprised of assets like venture, that are private and illiquid and therefore difficult to price — that don't mark to market often (usually only during a round). But they also hold a ton of public equities (far more than venture) that mark to market every second of the day and that all got crushed. So now to figure out their actual allocation to VC, you take the still-inflated aggregate value of their VC investments and divide it by the now destroyed aggregate value of their public equities portfolios (and, by the way, the same with their bond portfolios — remember, rates have been rising faster than in decades), and the result is a portfolio that was targeted to be 10% VC and that is now 60% VC.

And, since rates have risen so much, risk tolerances are actually lower (when prices are better — go figure), everybody experiences a flight to quality, and cash is both more needed and more rewarded.

All of that then marries together to cause LPs to (1) cut the number of managers with whom they work and (2) commit less going forward to venture as an asset class and sometimes (3) to make 0 new commitments to venture for some period of time.

Now, the irony? There has never been a better time in recent memory to commit to a brand new, size-bound fund.

• A new fund is not sitting on a bunch of assets that it bought at inflated prices and that haven't even been marked to market yet.

• A new fund can deploy capital at the correct part of the cycle (when prices are lower and more reasonable) and, because it's new, won't have pressure to realize returns until the natural other side of the cycle (when prices have risen - irrationally or otherwise).

• A new smaller fund can be more easily actively managed - e.g., finding opportunities for secondaries without creating signal risk.

• ALL of the research shows that the best returns in venture are in smaller funds. Very few large funds produce significant returns historically.

• An actively managed new fund focused on resourcing the most resilient founders in the most resilient markets has a huge competitive advantage over momentum-focused follow-the-crowd type investing in all typical markets (like the one to which we have returned).