Friday Letter: Investor sentiment for VC continues to sour

Institutional investors are pulling back from venture funds and spending more time managing their private equity portfolios through secondary sales, a new Probitas Partners survey says.

Institutional investors are battening down the hatches, pulling back from venture funds and spending more time managing their private equity portfolios through secondary sales.

That is the big takeaway from Probitas Partners’ new survey of 70 institutional investors, including funds of funds, public pensions, endowments/foundations and family offices.

Probitas managing director Kelly DePonte gave Venture Capital Journal a peek at some preliminary survey results in early November. As we noted then, LP interest in US venture capital took a major hit after being named the third most popular segment of private equity in the 2021 survey. The new poll shows just 38 percent of LPs plan to target US venture next year, down from 54 percent who said they would target it this year.

The largest portion of LPs (66 percent) said they would target US middle-market buyouts, followed by US small-market buyouts (56 percent) and US growth capital funds (47 percent).

Given that the survey happened in the weeks prior to the collapse of VC-backed FTX, the perception of VC could have been worse. “The biggest market issue that has raised its head after the survey closed was the FTX bankruptcy and the knock-on effects in cryptocurrency generally,” DePonte said. “It not only raised major questions about cryptocurrency investing, but also highlighted the poor due diligence done by major VC firms who seemed to be driven by the fear of missing out on what, in retrospect, seems to be the top of the market. Would that have driven VC even further down in LP interest if it happened as the survey started taking responses in early October? Will it erode confidence in VC in 2023?”

Looking more closely at venture capital in three major geographies, VC funds in the US and Asia were hit the hardest. Just 9 percent of LPs said they would target Asian venture capital in 2023, down from 21 percent this year. European/Israeli VC was less impacted, with 13 percent saying they would make it a target, down from 16 percent in the prior survey.

The negative perception of venture is across all fund stages. The portion of LPs focused on early-stage funds plummeted from 59 percent in last year’s survey to 49 percent this year, while those interested in late-stage funds fell from 46 percent to 33 percent, and investors focused on seed funds went from 43 percent to 31 percent.

The percentage of investors that said they don’t invest in venture funds grew from 22 percent last year to 28 percent this year.

Another notable change from last year’s survey: LPs are less enthusiastic about VC funds focused exclusively on technology and life sciences. Both sectors tied for most popular last year, with each getting 24 percent of the vote. Tech-only funds fell to 21 percent in this year’s survey, while life sciences-only funds dropped to 16 percent.

LPs are now more interested in VC funds that target multiple sectors, with 24 percent of those surveyed giving multi-sector funds a thumbs up, an increase of 6 basis points from the previous year.

Given the ongoing troubles in the crypto space, it makes sense that just 9 percent of LPs said they were interested in blockchain/crypto funds, down from 13 percent a year earlier. (Note that the survey was conducted in the last three weeks of October, before the meltdown of crypto exchange FTX in November.)

The declining interest in venture comes at a time when LPs are actively trying to get the most out of their existing portfolios. Nearly half of respondents (47 percent) said they have sold or are considering selling funds on the secondary market, up from 39 percent last year, “as more investors under stress were looking to generate liquidity,” Probitas said.

The response isn’t surprising given that quite a few LPs have found themselves over-allocated to private equity after a sharp decline in the public markets. As we reported last week, several large public pensions have cut back sharply on their pacing plans for next year due to the denominator effect.

While the increasingly negative sentiment for venture funds is concerning, it isn’t clear how it will impact fundraising next year. Things feel relatively normal right now. We continue to see new funds being announced virtually every day, both large and small. To be on the safe side, VC fundraisers should close on new vehicles before negative perception turns to reality.