Changes in the VC Fund-Raising Game

ELAINE: No, no.. but it is quite a coincidence.
RAVA: Yes, that’s all, a coincidence!
ELAINE: A big coincidence.
RAVA: Not a big coincidence. A coincidence!
ELAINE: No, that’s a big coincidence.
RAVA: That’s what a coincidence is! There are no small coincidences and big coincidences!
ELAINE: No, there are degrees of coincidences.
RAVA: No, there are only coincidences! ..Ask anyone! (Enraged, she asks everone in the elevator) Are there big coincidences and small coincidences, or just coincidences? (Silent) ..Well?! Well?!..

                      — Seinfeld, “The Statue” (April 11, 1991)

Dan Primack of PE Week Wire argued entertainingly this morning that venture investors are full of shit when they say that fund cycles are five and ten — five years to invest a fund that has an overall life of ten years. While that might have once been the case, it changed during the bubble to more like two years to invest, and it has never gone all the way back.

Dan’s explanation why? VCs can’t predict the future, so they end up investing faster than they expect. That’s why KP is fund-raising in New York this week, despite having just raised a fund back in 2004. To Dan’s way of thinking, all VCs are adrift at estimating their own investing pace.

Maybe, but if it was simply that VCs can’t get a good handle on their pace of investing, then you would expect a pseudo-normal distribution, with half of investors investing too quickly and half too slowly. What’s happening today is almost all venture investors are putting out money faster than they supposedly expected when they raised their fund. While it’s possible that it’s just a big coincidence, it would be quite a coincidence.

A cynic might argue that VCs are investing faster than they say they will because it’s a way of having more fee-generating money under management without raising larger funds. When you are earning lower returns from venture investing, and when LPs encourage you to raise smaller funds, it is perfectly economically rational to raise smaller funds faster to end up in the same high-fee place.

You could also argue that there is a tournament effect going on, with large pools of capital and a continued venture overhang leading to investors feeling like they must outpace one another to maintain position. Historically such was not the case, so the transformation of venture investing into a tournament has confused venture investors.


  1. Motts McGregor says:

    Agree with your suppositions, but let me throw one more out.
    A larger percentage of companies are being funded via “1-3-5” type stages, where a larger percentage of the total capital to-be-invested is being reserved for future rounds.
    There are some post-bubble motivations for this I think. Here are three: 1> we “need to be able to clean up our own messes if necessary” thinking among GPs, as the bubble showed the fragility of syndicates; 2> certain types of VC-backed projects are going to be very costly, and “we’ll be damned if we put the money in all at once like we did back in 2000”; and 3> the firms that can raise a new fund rapidly are the ones with deep LP relationships, strong track-records, and the resulting high confidence. As the post-bubble shakeout weeds out a lot of other firms, the ones who are left are more likely to fit the above description.
    The net result is that firms are saying “we’re done investing this fund” when a rather small portion of the capital has been drown down and actually deployed. But it is all allocated, and thus it is time to go out for some fresh cash.

  2. Thanks Motts. I buy the “1-3-5” hypothesis, and have definitely seen it in action. Interesting interpretation. To that way of thinking, they still are on the 5-year model, it’s just the new way of allocating across rounds has them pre-committing the whole fund early.
    One implication: As they realize that many “1”s aren’t going to turn into “3”s, let alone additional “5”s in commitments, there is likely to be a mini-spike of freed-up capital late in these funds’ cycles.

  3. Motts McGregor says:

    I agree on the implications of this Paul.
    What happens with this freed-up capital? Well, the LPs ARE a wee bit more accustomed to “we’re cutting the size of the fund for your benefit (oh, and our benefit too of course, now that we’ve raised the next fund already)” after some of the bubble-era funds were cut down.
    So, it’s nice, but still presents a bit of a problem for LPs who are trying to manage a stable % allocation to venture partnerships. This is a new variable to consider.
    On the GP side, they may be drawing down money on 2 or even 3 funds simultaneously for active investments. To my knowledge that is a genuinely new phenomenon.

  4. Yes, the drawing down on multiple funds simultaneously is the one that got my attention. That is new, and it is going to be messy to manage its implications. Kind of like being able to revise history, there will be this inordinate tempation to goose the performance of prior “closed” funds.