Venture capital reckons with the end of ‘megafund’ era

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Venture capitalists are struggling to raise money, signalling the end of an era of “megafunds” and a slowdown in start-up dealmaking over the coming years.

Globally, venture firms raised $30.4bn from university endowments, foundations and other institutional investors in the first three months of this year, a marked slowdown from 2023 — which itself was the worst year for fundraising since 2016, according to private markets data provider PitchBook.

Investors in venture funds, known as limited partners, have reined in spending over the past two years, taking a more cautious approach as interest rates have risen, start-up exits including public listings and sales have slowed and returns from venture fund managers have cratered.

“Why has there been such a sustained slowdown? At the core of the issue is exits,” said Kaidi Gao, a venture capital analyst at PitchBook. A resurgence in initial public offerings or sales would allow LPs to recoup their invested capital and recycle it.

“Unless we see meaningful improvements from the exit market we’re expecting fundraising difficulties to linger and that will put downward pressure on dealmaking,” Gao added.

Fundraising activity has slowed sharply since 2021, when VCs hauled in $555bn. Last year, they raised a third of that total, and activity has continued to slow, putting venture investors on course for their worst fundraising year since 2015.

In the US, just $9.3bn in capital was raised in the first three months of this year, roughly a tenth of the total raised in 2023.

“We want to be there for our partners, but we don’t want to put ourselves in a hole,” said the chief investment officer at one big US foundation. He pointed out that he and other LPs had written ever-larger cheques as the market boomed but are yet to see a return because exit activity has stalled. “It’s tough maths for a lot of investors.”

The sluggish pace of fundraising is an ominous sign for start-ups, who rely on VC investment to grow in their earliest stages. It continues a sharp reversal in VC firms’ fortunes since 2021, when they spent a record $747.5bn in 2021, according to PitchBook. The splurge was made possible in large part by the advent of “megafunds” — vehicles of $5bn-$10bn that created a period of unprecedented abundance for start-ups.

That era is now over, according to PitchBook: Fundraising data for the first quarter “shows there may be no appetite for such vehicles in today’s market”.

Some of the biggest spenders in the boom years — including Tiger Global, Coatue, SoftBank and Insight Partners — have cut the size of their funds and slowed the pace of their investment.

Tiger closed its 16th fund last week, having received $2.2bn in investor commitments. The firm’s last fund was a $12.7bn vehicle raised in 2021. Insight, which raised $20bn in 2022, has also pared back ambitions for its latest fund.

The chief investment officer said: “I would be very surprised if in five years the industry hasn’t shrunk by half. The returns aren’t there . . . Usually the depth of the downturn is in proportion to the magnitude of the bubble, which would imply we’re in for a brutal time.”

VCs are now gambling that a boom in artificial intelligence will provide a generational opportunity and help “overcome the sins of 2020 to 2022”, said Venky Ganesan, partner at Silicon Valley firm Menlo Ventures. “Every venture firm is chasing the AI unicorn. Some are going to get it and will thrive, those who don’t will be sent to the dustbin of history,” he said.

VCs that raised large funds before the market turned still have billions of dollars of “dry powder”, but have been reluctant to invest in start-ups whose valuations have been rocked by higher rates.

Increasingly, they are focused on helping companies already in their portfolios towards exits which would then allow VCs to return capital to their own limited partners.

A smattering of successful public listings for venture-backed companies, including social media site Reddit and chip company Astera Labs last month, have raised hopes for a more widespread revival of the US IPO market. Rubrik, a data security start-up, filed for an IPO earlier this week.

But Gao cautioned it would take more than a handful of successful public debuts to kick-start the market.

“When [marketing automation software company] Klaviyo and [online grocery start-up] Instacart went public last September, there was a lot of excitement about this being the restart of IPOs, but there were lots of [share price] fluctuations,” she said. “It’s not just about the splashy IPO debut, we need to give it more time to see how performance has stabilised.”

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