Limited Partners Navigate Venture Capital’s Liquidity Challenges
Limited partners (LPs) investing in venture capital firms are facing significant challenges as the industry undergoes a liquidity crisis. At a recent panel hosted by StrictlyVC in San Francisco, prominent LPs representing over $100 billion in assets discussed the evolving landscape of venture capital. They highlighted that funds are lasting longer than anticipated, creating a range of complications for institutional investors.
The panel revealed that the lifespan of venture funds is now nearly double what it used to be. According to Adam Grosher, a director at the J. Paul Getty Trust, traditional expectations suggested funds would last around 13 years. However, his firm currently holds investments in funds that are 15, 18, and even 20 years old, still retaining valuable assets. Grosher remarked, “The asset class is just a lot more illiquid than most might imagine,” which is prompting LPs to reevaluate their investment strategies.
Shifting Allocation Models
In light of extended fund lifespans, LPs are adjusting their allocation models. Lara Banks from Makena Capital, which manages $6 billion in private equity and venture capital, noted that her firm now anticipates an 18-year fund life. Most capital returns are expected between years 16 and 18, leading to a more conservative approach to capital deployment.
The need for active portfolio management is becoming increasingly important. Matt Hodan of Lexington Partners, managing $80 billion, emphasized the necessity for LPs and general partners (GPs) to engage with the secondary market. “If you’re not, you’re self-selecting out of what has become a core component of the liquidity paradigm,” he said.
The stark contrast between portfolio valuations and market realities is also troubling. Hodan shared a conversation he had with a general partner, revealing a portfolio company valued at 20 times revenue was recently offered just 2 times revenue in the secondary market—a staggering 90% discount. Michael Kim, founder of Cendana Capital, which focuses on seed and pre-seed funds, noted that some firms might face markdowns of up to 80% on their perceived top performers.
The Emerging Manager Dilemma
The current fundraising climate poses significant difficulties for new fund managers. Kelli Fontaine from Cendana Capital highlighted that established firms like Founders Fund have raised 1.7 times more than all emerging managers combined in the first half of this year. Institutional LPs, who previously invested heavily during the pandemic, are now prioritizing quality and concentrating their investments in established funds.
As institutional investors pull back, the influx of “tourist fund managers” from the 2021 boom has largely diminished. Grosher noted that many institutions overexposed themselves to venture capital and are now reassessing their strategies. Banks confirmed that while her firm has maintained a steady number of new manager investments, larger sums are allocated to established funds.
Despite these challenges, Kim identified a silver lining: the decreased presence of less experienced fund managers. This has opened the door for more serious and committed investors to emerge, enhancing the overall quality of the venture landscape.
The panelists discussed the evolving nature of venture capital, with Kim echoing sentiments that venture may not qualify as a distinct asset class. He pointed out that unlike public equities, where returns cluster closely, venture capital yields a wide dispersion of outcomes. This variability complicates planning for institutions like the J. Paul Getty Trust, which seeks a balance between established platforms and emerging managers.
As LPs navigate this complex environment, they are increasingly focused on optimizing returns. Fontaine noted that a third of her firm’s distributions in the past year came from secondaries, not at discounted prices but at premiums to prior round valuations. This shift reflects a growing acceptance of secondaries as a legitimate strategy rather than a sign of mismanagement.
In conclusion, the venture capital landscape is undergoing a significant transformation, with limited partners adapting to extended fund lifespans and a challenging fundraising environment for new managers. These developments are reshaping how institutional investors allocate capital and engage with the market, ultimately influencing the future of venture capital as an asset class.
