Follow me @samirkaji for my thoughts on the venture market, with a focus on the continued growth with the emerging manager landscape.
Last week during the 4th annual emerging manager RAISE conference, my colleague Hana Yang gave a great presentation covering the results of a LP survey that was conducted to assess LP temperament heading into the remainder of 2019 (linked here is the 2018 survey did last April).
The sample size of the survey was 100 LP’s spanning from non-institutional LPs such as Family offices and High Net Worth individuals to institutional LPs such as fund of funds, foundations, endowments, pensions, and RIA’s. As much of our work is working closely with GPs and LPs in the emerging manager space, many of the findings confirmed our anecdotal views of the current fundraising landscape (according to Preqin data, there are 900+ US venture funds currently in market!)
The presentation deck for the survey can be found here, but below is a summary of the primary takeaways.
· As expected for such a emerging manager focused survey, the majority of respondents (67%) were family offices and Fund of Funds, which have been the two most active allocators to emerging venture funds (more on this later). To put a finer point on this, when we conducted a GP survey back in November of 2018, we found that only 33% of capital in Fund 1 offerings were from institutional LPs (compared to 50% institutional backing in Fund III)
· According our analysis from Q4 2018, the average first time VC fund raised in 2018 was ~$33MM, and as expected for that fund size, the majority of LPs participating in those funds are those that can write checks of <$5MM. In our survey, 93% of LP commitments coming from Family offices were sub-$5MM, as were 60% of LP commits by Fund of Funds. The pension funds that participated in the survey conveyed that 100% of their allocations to VC were >$10MM, making them a very unlikely fit for most emerging manager funds.
· One of the key elements of an emerging manager fund pitch often is offering LPs co-investment opportunities through contractual pro-rata rights the manager has in follow-on rounds , which cannot be absorbed by the fund giving fund sizing (typically B round and later). While in practice, we have found only a small % of LPs actually participate in co-invest (typically through SPV’s), the option to do so remains very compelling to non-institutional LPs. In our survey, nearly 3/4 of non-institutional respondents noted that their preference was to allocate to smaller funds that offered co-invest.
· In terms of active allocators to VC, Fund of Funds are expected to be the most active in adding new names to their portfolio (Fund of Funds will add an average of 8 new VC names, with 4 of those allocations going to emerging managers) over the next 12 months. While encouraging, note that there were some outliers, and if we remove the top 2 Fund of Funds from the sample set, the allocation numbers dropped to just under 5 and 3 for new names and emerging managers respectively. For family offices, the data from the survey was ~3 new VC names on average, with 2 of them being emerging managers (no major outliers). These numbers were effectively identical to our 2018 survey, and with over 10,000 global family offices, this group clearly will remain the predominant capital source for the emerging manager ecosystem.
· There was precipitous drop in interest in thematic funds as only about a third of LPs polled said they preferred a thematic fund. While new thematic funds continue to come to market, the survey signals that many LPs are not viewing a theme based thesis alone as significantly compelling. As an extension to this point, we believe that many LPs believe that very little differentiation or advantage is present for most thematic funds relative to generalist funds.
· In aggregate, LPs continue to be relatively apathetic toward geographically focused funds, but it was interesting to note the nearly doubling of preferential interest by non-institutional LPs year over year of geographically focused funds. Given the continued growth of non-coast tech hubs in the US (that often present much lower valuations for startups), I think this is one of the most intriguing areas to monitor in the coming years.
· While there is a clear preference for multiple GP funds over sole GP funds, nearly 60% of non-institutional LPs conveyed either neutrality on the topic or a preference toward sole GP funds.
· As many managers have experienced, institutional diligence and allocation cycles are often quite protracted, with these LPs commonly wanting to form relationships over fund cycles prior to committing. As such, it was surprising to see that nearly 60% of Fund of Funds and Endowments indicated that they were able to go from first meeting to allocation within 6 months. Irrespective of this data, I wouldn’t expect this to case more broadly if the sample set was increased. Unsurprisingly, family offices expressed the quickest time of allocation, with over 80% stating a total time frame of <6 months.
· Overall venture market confidence from LPs on a 1–10 scale was 5.9 (Fund of Funds were the highest at 7.2). Likely contributing to this score are growing fears of a macro disruption, rising valuations, and an increasingly crowded venture ecosystem.
· As usual for venture investors, illiquidity within the asset class remains a a major problem for LPs. Although venture (unrealized) performance as an asset category has been strong over the last decade, the lengthening liquidity cycle continues to be a thorny issue. Despite what is expected to be a very strong IPO market in 2019 and perhaps 2020, LPs in the survey continued to be clear that they wanted managers be active on private secondary opportunities when possible.
Special thanks on the survey to Hana and Elie Chalhoub for parsing through the data and providing the analytics.