Investors flock to venture capital despite market downturn

Investors backing venture capitalists continue to pour money into the sector, eager for access to hot tech startups even as the industry sinks into a bear market.

Venture capital funds raised $151 billion in the first three quarters of this year, outpacing any previous full-year fundraising, according to newly released information from PitchBook Data Inc. The money has been concentrated in fewer and larger funds, such as Sequoia Capital’s $2.25. billion and Lightspeed Venture Partners’ $7.1 billion from July. But even rookie fund managers, who tend to struggle in downturns, have so far shown resilience. Newcomer funding is on track to match or surpass nearly every year before 2021, according to PitchBook.

The push hit a record near $300 billion in so-called dry powder, or free money to spend.

Many family offices, sovereign wealth funds, funds of funds and other so-called sponsors remain staunch supporters of venture capital firms, believing that tech trends such as cryptocurrency and artificial intelligence will survive any economic downturn. Historically, venture capital has offered better returns than other asset classes, even in times of recession. Venture capitalists are still hoarding larger sums of money than ever before, despite the widespread decline in tech stocks and lingering inflation.

“We are actively writing checks, said Michael Kim, founder of Cendana Capital, which invests in early-stage venture capital funds. Mr. Kim said his company’s pace of investment remains as active as it was at the height of the pandemic – early-stage startups are more insulated from macroeconomic trends.

“I think venture capital is in a good place,” he said. “There is enough capital.”

There will definitely be pain along the way. Venture capitalists will have to write down their portfolios to reflect declines in public markets. With few opportunities for startups to go public, there will be fewer exits for venture capital funds and less money to return to their sponsors. Venture capital partners said they expect valuations of some startups to stagnate for years and the number of startups in their portfolio that fail to increase by around 10%.

“I spend a lot of time thinking about companies that might run out of money,” said Chris Douvos, founder of Ahoy Capital, a fund that backs early-stage venture capital firms.

The partners in the venture capital firm decide how to invest the money and collect a fee from the sponsor based on the amount of money they manage. Venture capitalists will need some of that money to back their existing portfolio companies — some say they waste 30%-40% of their funds on startups that might struggle to raise money from new ones. investors. But there will be plenty left to spend on new offerings, they say, when the price is right.

PitchBook’s research in 2022 includes funds that were partly raised in the friendlier 2021 market – an average venture capital fund takes about a year to raise. Yet the momentum has not waned. In September, Bessemer Venture Partners closed a $4.6 billion financing and Scale Venture Partners closed a $900 million fund; in October, Lowercarbon Capital announced a new $250 million fund.

Tusk Venture Partners, co-founded by political strategist and startup investor Bradley Tusk, is expected to start raising a new fund in the first quarter, after closing one in April, according to a person familiar with the matter. Cybersecurity-focused venture capital firm Forgepoint Capital is raising a new fund of up to $750 million, according to a securities filing. Traders from Tiger Global Management LLC and Coatue Management LLC recently left to raise their own seed money.

Over the summer, Sarah Guo decided to launch her first fund, Conviction. Ms Guo, who spent nearly a decade at venture capital firm Greylock Partners, said she raised $101 million in nearly three months. She said at least one sponsor asked her if she was crazy about starting a fund during a downturn.

“You just become immune to all the reasons why you shouldn’t be doing something at any given time,” Ms Guo said. She added that she expects her fund to perform much better than if she launched it when valuations were higher and she would have overpaid for startups.

Venture capital has outperformed other asset classes in previous down cycles. About 75% of venture capital funds raised from 2007 to 2016 beat the Russell 2000 during that time, and about 60% beat the S&P 500, according to a 2021 research paper published in the Harvard Business Review. According to a University of Miami study, venture capital returns during the dot-com crash and recession of 2007-09 recorded an average gain of 16%, while the S&P 500 lost 12% and the Nasdaq fell 18%.

Yet the months-long plunge in public stocks has left some university endowments and public pensions overexposed to venture capital, where on-paper valuations remain grossly inflated. Now, some of these funds have illiquid asset allocations that far exceed the amount that investment managers had targeted or their investment policies allow. A recent survey by investment bank Jefferies Financial Group Inc. found that some asset managers, including endowments and pension plans, are less interested in venture capital investments in 2022 than in previous years. . Jefferies concluded that there was a “limited appetite” for adventure among survey participants.

The withdrawal of some major asset managers has given way to an influx of sponsors from Europe, China, the Middle East and Singapore. Many Asian funds have offices in Singapore, and several venture capitalists said they had traveled there in the past two months to seek funding. Sovereign wealth funds have approached venture capital firms more frequently as many have abundant capital thanks to gains from high energy prices, venture capitalists and lawyers working on deals have said. of financing.

Sponsors say they are more selective about who gets their money. Some want venture capital funds to spend their money more slowly and demand due diligence on transactions, the makers said.

“There’s more time for information, and it feels clearer and healthier,” said Beezer Clarkson of Sapphire Partners, which funds early-stage venture capital firms. She said Sapphire has maintained its pace of investments this year, including funds focused on cryptocurrency and digital assets. “You have to invest in down cycles as well as up cycles,” she said, “because you don’t know when the next 10-year bull market is going to start.”

—Heather Gilles contributed to this article.

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