Venture capital’s $300bn question
Take a look at the following puzzle. Venture capitalists have raised a record $150bn in fresh money, which was $150bn more than they had ever raised. Despite the market slowdown, they set a new record in 2022 when they raised more than $160bn. Chunks of this have already been spent, but close to $300bn of “dry powder” sits waiting to be put to use. Spending fell through 2022. It appears that fledgling companies are cheap. Venture capitalists are sitting on cash, so why is that?
Like many other finance puzzles, the key lies in the rapid rise of global interest rates over the past year. As investors move capital to safer assets like cash or government bonds, higher rates have led to a decline in stock prices. Over the past year, tech-rich nasdaq has lost more that a fifth its value. The stockmarket listing capital raised fell to a 32 year low in 2022. Public-market slowdowns such as the one currently in progress reduce expected returns for investors in private markets by lowering the valuation at which startups “exit” into public markets. Venture capitalists are therefore willing to pay lower prices for their investments.
Late-stage startups, which in normal times could be close to a public list, are particularly affected by this. Firms that have raised a lot of cash in 2021 are opting to delay deals and wait. The smaller number continuing with plans must hope to avoid a dreaded “down-round”, in which a startup raises cash at a lower valuation than in a previous round—a let-down for employees and early investors who are forced to confront losses on their shares. Investors are less inclined to take a chance on more risky opportunities. They cannot rely on another backer to follow them into a deal, or help make it a success with raw cash or expertise.
The second part is more complex. Venture capitalists could theoretically spend the money they have. The money is already committed to their funds. Some firms would be able to do this to avoid management fees. These fees only apply to invested capital and are not merely committed to the funds.
Spending at an alarming pace could prove to be costly in the long term. Venture capitalists often raise money from limited partners like pension funds or endowments. These limited partners want to decrease their exposure to venture capital. Public markets have suffered and many of them are trying to maintain rough allocations to different asset classes. As a result, a handful are calling up venture-capital funds to say things to the effect of “don’t rush back” for more money, says an investor in several venture-capital funds.
Venture capitalists are paying attention. Harry Nelis is a partner in Accel Venture Capital. He speculates that the cash that was once spent during the boom might now last three times as long. Spending could be even more slow. Venture-capital funds don’t actually hold the money in their bank accounts. Instead, funds must make “capital calls” to their limited partners when they want to finance an investment. This forces the limited partners to take cash out of their portfolio to finance an investment. They are often unable to do this in stressful times. The fund managers are aware of the fact that they want to return to their partners in the future and so avoid annoying them by calling at odd times. Indeed, in 2001, during a slowdown which followed the dotcom bubble, some investors even “returned” committed funds to limited partners, so that their partners could reallocate the money as they wished.
Venture capitalists should be worried about their relationships with limited partners. The recent boom saw funds look at issues beyond their usual concerns. Sequoia Capital, a famous outfit in Silicon Valley, launched a “superfund” which includes investments ranging from traditional venture-capital interests to public-market shares. Although some limited partners found these funds too broad, they decided to purchase in to access specialist funds. It’s not surprising that venture capitalists are trying to improve relations with their limited partners and slamming the rules. At least as long as market conditions remain miserable, the industry’s world-conquering ambition will remain on hold.
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