The funds-of-funds problem

April 19, 2011, 7:43 PM UTC

Funds-of-funds holding final closes. Source: CapitalIQ

When people talk about VC or PE fundraising booms, they often talk about a new type of capital source. Think public pension funds in the 1990s or sovereign wealth funds last decade.

Yet for some reason, the same discussion doesn’t much happen when it comes to fund-raising valleys – like we’re currently experiencing. It’s just blamed on a macro commitment phobia, or lingering PTSD from the 2009 liquidity drought.

What I’m wondering, however, is if the funds-of-funds community isn’t one of the primary brakes on today’s VC/PE fund-raising market. Not intentionally, mind you, but because such vehicles — often a major supporter of first-time funds, and arguably the leading investor in venture capital — are having a very tough time raising new capital of their own. According to Capital IQ, for example, only two PE/VC funds-of-funds held final closes last year, compared to 11 in 2009 and 48 in 2008.

There are strong arguments to be made on behalf of certain funds-of-funds, but they now seem to be drowned out by this institutional investor thought: “If PE/VC firms are really so desperate for cash, why do I need to pay an intermediary to gain access?”

Makes short-term sense from a limited partner perspective, so long as it has enough in-house capability to conduct due diligence (which, sadly, most do not). From a long-term perspective, however, it may reduce the number of future opportunities…