What are venture focused Limited Partners are thinking today?
Follow me @samirkaji for my thoughts on the venture market, with a focus on the continued growth with the emerging manager landscape
If it wasn’t clear a few months ago, it is abundantly clear now that not only has the world has shifted immeasurably from COVID-19, but the very definition of what is “normal” is forever changed.
What appeared to be a virtual impossibility back in March, the equity markets have hardly flinched with US equities currently down only ~15% from record highs & the private markets (particularly early/growth) still showing plenty of forward momentum.
However, when the US public markets were down nearly 40% in March, most had assumed that the capital faucet for venture funds and companies would drip dry for the remainder of 2020.
While the capital markets are certainly muted from the 2018/2019 high water points, there are clear signs that capital has not dried up the way many, including myself, predicted — Given the fluidity of the macro environment, this could of course change at any moment.
To understand what Limited Partners are thinking today, we decided to run a short survey with nearly 100 LP’s to understand their current view on allocating to venture funds.
The survey is linked above, but here are a few summary points:
• 44% of the respondents were Family Offices, a function of our focus on building relationships with the type of Limited Partners that have historically been most active in emerging funds.
• The remaining 56% were institutional investors, with the largest majority being Venture Fund of Funds at 33%.
• When I spoke to institutional LPs back in April, very few said they were comfortable allocating to managers they had not built a previous relationship with unless a site visit was conducted. While it remains true that institutional capital is available for only 5–10% of emerging managers, only 10% of institutional LPs definitively conveyed they would not allocate to a new name w/o a site visit (32% said they were not sure). I suspect much of that 32% will move toward finding comfort in doing allocations without a site-visit as it becomes evident that free travel is likely 12–18 months away and many VCs may choose to eschew physical office spaces in the future. I do expect that the intensity of reference checks and Operational Due Diligence to increase to make up for the lack of in-person contact.
• Unlike 2008–2009 when balance sheets were imperiled and the denominator effect created mass over allocation to private equity assets, the current market climate is decidedly different for LPs. Liquidity remains strong and with the reduction of yields in traditional fixed income instruments, venture capital continues to be a compelling haven for those seeking alpha return potential. Note that for the LPs we surveyed, ~10% of total assets were held in venture.
• The fears around widespread defaults on capital calls has not been realized thus far and was further confirmed by our survey — — None of the LPs remarked they had any concern about defaulting on a capital call in 2020 (that said, we have spoken to LPs who have strongly urged GPs to slow deployment; this isn’t surprising as fast deployment and short cycles between funds were a point of contention pre-COVID-19 and a noted pain point in our survey.
• In terms of allocation interest, seed stage firms were the highest area of interest for both institutional and non-institutional investors. Only a small % of institutional firms (15%) noted that backing underrepresented managers were an area of particular focus (note that many of these survey results were conducted in the early days of the George Floyd tragedy and the subsequent spotlight on racial inequity). While we are hopeful this number increases, indicated interest on a survey will mean little without actual allocation activity, which we will eagerly await.
• Confidence in the venture industry remains high at a median of 8 for all investor types. Anecdotally, many LPs I spoke to were more excited about allocating today vs. pre-COVID-19; these LPs cited lower valuations, better investment discipline by managers, stronger corporate governance by companies, and a belief that the pandemic dramatically has accelerated the trajectory of the innovation curve.
If you are a limited partner that actively invests in venture capital and would like access to future reports on the venture industry (or to compare notes on the sector or emerging manager market), please feel free to email me at skaji@firstrepublic.com to be added to the list.
