Earlier investment from late-stage VCs helps push growth of opportunity funds

Peter Wagner of Wing Ventures and John Backus of PROOF see the boom in opportunity funds as a means for smaller VCs to stay relevant to companies.

Growing valuations and earlier investments from late-stage funds have encouraged VCs to take advantage of opportunity funds, two venture capital founders say.

Peter Wagner, founding partner of early-stage investor Wing, said an increasing trend of late-stage investors pushing earlier and earlier in the funding rounds means smaller funds have to make a case for greater relevance.

“A lot of early-stage investors are raising opportunity funds and that is part of their response to play a more substantial role, both in terms of their own ability to invest, but also to be relevant to the companies for a longer period,” Wagner said.

Wagner pointed to a report by Wing in May that found the size of US seed financing at the end of 2020 continued to grow as late-stage investors move further downstream to invest at earlier stages. Median seed financing grew 33 percent to $40 million in 2020 from $3 million in 2019. Essentially, the report said, a 2020 seed is now priced like a Series A from 2010.

Meanwhile, the same report said median Series A deals in the US went up 5 percent to $13 million in 2020, compared to $12.4 million in 2019. Last year, 57 companies closed Series A rounds greater than $20 million.

“Some of the opportunity funds are a reflection of the scaling of the industry as technology plays a larger and larger role,” Wagner said. “Folks have redefined what a Series A really is where it’s more of momentum financing now.”

Smaller VCs typically focus on the early stages of investment since capital usually isn’t as great as in the later stages. Venture Capital Journal previously reported that smaller funds could capitalize on the early stage even though mega-fundraising continues to grow.

Unicorns riding high

For John Backus, co-founder of PROOF, it’s less about competition against larger funds and more a way to access start-ups whose valuations are going through the roof. Backus’s former firm, Draper Atlantic (now called New Atlantic Ventures), was one of the first to raise an opportunity fund in 2004.

“We’re at a bit of an unusual point in time, where we have a large number of companies raising up rounds quickly,” Backus said. “It’s easier to raise an opportunity fund because you have a lot more things you can point to in your portfolio that are doing well.”

In launching PROOF, which stands for “PRO rata Opportunity Fund,” Backus partners with other early-stage funds by providing capital when they exercise their pro rata for their portfolio companies.

Backus noted that if the current market was in more of a downward trend rather than spiraling up, there wouldn’t be as many opportunity funds.

Data from CB Insights said there are currently 704 unicorn companies worldwide with a cumulative value of $2.28 trillion.

“But because so many companies are doing so well, it gives more people the ability to go to their LPs and say, ‘Look at our portfolio. We should double down in these companies,'” he said.

Backus added that the number of VCs looking to raise opportunity funds proves how successful it is as a fund strategy.

“If you get a unicorn and you put in a million dollars or 10 percent of the company, then it goes out to raise a $100 million round, you have the right to buy 10 percent of that,” he said. “But that will be 20 percent of your $50 million fund. So instead of walking away from that, an opportunity fund lets you monetize that right. It’s as simple as economics.”