The illustration for our latest magazine is an homage to the 1958 sci-fi classic “The Blob.” We couldn’t think of anything more fitting to tell the story of our ranking of the VC industry’s 50 largest firms, which collectively raised more than $309 billion over the prior five years, a 46 percent increase from our 2021 ranking.
But it is looking more and more likely that the VC fundraising blob will start to shrink next year, as fundraisers are expected to run into a much more difficult market. Preliminary data from placement agent Probitas Partners’ annual survey of institutional investors shows a sharp decline in interest in VC funds around the globe.
For the US market, just 38 percent of LPs say they will target venture capital in 2023, down from 54 percent in 2022. For Asia, it’s a meager 9 percent, down from 21 percent, and for Europe/Israel, just 13 percent of LPs say they will target VC next year, down from 16 percent this year.
Probitas surveyed about 70 institutional investors, with funds of funds, insurance companies and public pensions accounting for most responses. Probitas managing director Kelly DePonte shared some of the preliminary results exclusively with Venture Capital Journal. The final report is set to be published the first week of December.
Probitas found that US middle-market buyout funds (of $500 million to $2.5 billion) were the most popular sector of private equity, with 66 percent of LPs saying they planned to target them next year, but that was down from 71 percent in last year’s survey. The second most popular funds were small-market buyouts (less than $500 million), which are a target of 56 percent of LPs, up from 47 percent a year earlier. Coming in third place were US growth capital funds at 47 percent (down from 63 percent and second place on the prior survey).
US venture capital funds slipped from third place overall in last year’s survey to fourth place in this year’s survey. Why have LPs turned so bearish on VC?
“I think the volatility in tech this year is the driving factor. That’s what we’re picking up from LPs,” DePonte told VCJ.
VCs are also being negatively impacted by broader trends affecting LPs. DePonte said quite a few LPs hit their annual allocation targets in the summer because so many GPs came back sooner than expected with larger-than-expected funds. In addition, the sharp drop in the value of public market holdings resulted in many LPs being overallocated to private equity.
“Besides the public markets going down and the denominator effect, a lot of people are concerned about inflation and the effect that [it] is going to have on their current portfolios,” DePonte noted. “So, a lot of people are really uncertain about overall fundraising as they look ahead toward 2023.”
With so much uncertainty, VC looks far less compelling than it did a year ago, when LPs were still getting distributions from deals that were exiting in a robust market for IPOs and M&A.
Now, LPs are looking for ways to capitalize on distress in the market. About 37 percent of the institutional investors surveyed by Probitas said they would target special situations funds next year, up from just 15 percent in the prior survey. “That’s distressed investing, so that tells you what’s on people’s minds,” DePonte said.
If you expect to be in the market next year, keep in mind that LPs’ biggest concern about fund structure is the “level of general partner financial commitment to the fund.” About three-quarters of LPs said that was their top concern in Probitas’s latest survey, up from 66 percent a year ago.
The second biggest LP concern (at 63 percent) was about the “dramatic increase in fund sizes,” followed by “significant strategy drift since the previous fund,” which was cited by 60 percent of investors.
Take those concerns to heart when you’re on the fundraising trail. And make sure you pack for an extended road trip. Said DePonte, “The bottom-line message is that you need to be prepared for a longer fundraising, even if you have strong returns.”