A LOOK AHEAD
Good morning, Term Sheet readers. In today’s guest column, Upfront Ventures managing partner Mark Suster takes stock of how limited partners are feeling about the state of VC investing.
Every year Upfront Ventures surveys limited partners (LPs), the main source of capital in venture capital funds, and thus the main source of capital that goes to startups, to get an early-warning sense of the year ahead. (Leaving aside any black swans, of course.)
The results are in and a few things are clear (you can read the full deck here):
—Limited partners are at their most optimistic phase about venture since the great recession of 2007–2009.
—LPs believe that the venture markets have permanently changed and that there are now three distinct buckets in venture: seed, A/B, and growth stages.
—LPs have moved beyond their strict belief that there is “the best and the rest” and now acknowledge that some of the best performers in the past decade have been what, a decade ago, were emerging managers or non-existent. Among them: First Round Capital, Union Square Ventures, Lowercase Capital, Foundry Group, Spark Capital, IA Ventures, Founder Collective. All of these names were not started in Silicon Valley. LPs are now looking for a combination of “established top tier” and “new managers with differentiation.”
—LPs now view co-investment opportunities much more favorably than they did a decade ago. Almost half of all LPs are quite active in them and one-third say it’s one of the primary reasons they’re in venture.
—LPs we surveyed anonymously, ahead of the recent Presidential Inauguration, were overwhelmingly anti-Trump. Zero respondents said he was “the right leader” for our country; however, in equal numbers, LPs didn’t believe that a Trump presidency is likely to have negative consequences for the venture capital and startup industry.
Here are some details. (Many thanks to Chang Xu for her help to prepare and analyze this data.)
If you met with LPs to raise a fund in between 2009 and 2012, the most common refrain was, “We have too many managers and too many dollars in venture. We’re trying to limit our exposure.” That has changed dramatically in the past five years. At the tail end of this period, when demand was picking up for the industry, there was still a belief in venture that it only mattered to be among the top 10 funds in Silicon Valley.
There is no doubt LPs still want access to the most elite funds. But increasingly LPs have acknowledged that the industry has changed. Some of the best performing managers have come from new firms, and many are outside of Silicon Valley. LPs, it seems, are more open to “new names.”
As our industry’s riches have grown, and startups have stayed private for longer periods of time (and raised significantly more private capital than they did in the past), an increasing number of LPs have sought to do “co-investments” with the funds that they back, giving them more exposure to what they hope will be the better-performing portfolio companies.
Want to understand why LPs are so active in venture today? The most obvious reason is that technology startups have paid off handsomely for many LPs. (A more nuanced answer would include the phrase “relative to other asset classes.”) This is key. In a permanently low-interest-rate environment, parking large pools of capital in assets that benefit from interest is not possible, so LPs seek “higher yield.” I know most startups (or even VCs) tend not to think about this. But when you ask LPs, the data is clear.
Another trend we’ve noticed among limited partners involves seed funds. When people like Michael Kim at Cendana or Hans Swildens at Industry Ventures a decade ago started focused on “Micro VCs,” we heard many LPs saying, “I’m not sure if seed fund investing is really a smart strategy. Will it last? Will they get squeezed? Will they have enough capital?” We never hear that any more. Seed-fund investing is believed to be a permanent force in our industry, with too many great funds to list. (Aside from those I listed previously, there is obviously Felicis, Softtech, Floodgate, K9, Forerunner, Cowboy—and so, so many more that I’m already in trouble for not naming another 20, I suspect.)
Late stage/growth venture capital sucks up the most amount of capital in aggregate in our industry. There was a movement by some of the larger VCs to say that traditional VCs would “get squeezed,” but LPs don’t buy it. More LPs said that traditional A/B VC funds were the “best fit” for them than any other kind. But the reality is that most LPs wanted a “healthy mix” of seed, A/B, and growth.
As for President Trump: Not a single limited partner surveyed said Trump was the right leader for the United States. A clear 71% said they disliked Trump, were anti-Trump, or were “deeply offended” by Trump.
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