Recent PitchBook data shows that the journey from a first to a sophomore fund has never been so challenging.
Historically, when we examine the period from 2006 to 2018, 63% of first-time managers had been able to secure a second fund, however, the present environment is indicative of a much tougher journey that’s ahead of us.
Back in 2021, total capital that had been committed to U.S. first-time fund managers had totaled to about $14.7B across 318 funds.
And during the last couple years, those figures reached a sharp decline, with 2023 ending the year with just 97 first-time funds secured and less than half the capital of 2021 at $6.5B. This aligns or is consistent with overall Venture capital fundraising efforts as 2023 has been the second straight year established managers (funds 4 or more) took over 70% of total committed capital in the sector.
According to analysis and insights from OpenLP, which aggregates and amplifies insights across the entrepreneur and venture ecosystem, here is a worrying trend: More than 247 of the 667 first-time managers (2019-2021) that had finalized funds may not finalize a second fund. And 2024 seems to be shaping up to be quite a busy fundraising period with funds that planned to be back in 2024 plus those that did not intend to raise in this past year’s tough conditions.
According to OpenLP, competition for capital shouls be quite tough, and the lack of liquidity for the venture market has caused a number of LPs to reassess their allocations to venture, even with the current manager relationships. This might wipe out almost a year and a half of new Venture Capital manager entries.
The current fundraising decline is not simply about stats and/or numbers. In fact, it is indicative of a shift in the VC ecosystem. It is possible that we might witness an impact on emerging managers and the markets they work with as many LPs are forced to prefer working with more established managers with proven DPI.
Given instances where success rates decline 5-15% from historical averages, we might see as many as 347 first-time managers exit the market. This issue confirm the need for adaptability and resilience in the ongoing VC market.
Market participants are hearing from LPs that they’re further expanding the range and overall depth of their investor analyses beyond the conventional markers of success.
As US market volatility has picked up, the VC fundraising environment “has become
increasingly harsh, resulting in just under $67 billion raised in 2023, roughly $100
billion less than the amount raised by VC managers during both 2021 and 2022.
First-time fundraising by new venture capitalists reached a zenith in 2021 of $14.7 billion and has experienced a dramatic decline since, in large part due to the precarious position new managers have been in during the fundraising drought.”
The prolonged liquidity crunch “has made LPs more cautious of deploying—or outright unable to deploy—capital to VC managers without a strong track record or a strong, pre-existing relationship. As a result, investor capital that has flown into the ecosystem has increasingly clustered within funds led by established managers, which has starved their emerging-manager peers.”
The Pitchbook report added:
“First-time managers looking to raise their sophomore VC fund face a high hurdle to attract LP capital because they have minimal track records, as they are not likely to have realized significant, if any, exits within their portfolio. Not only that, but new managers that recently raised their first fund invested through the valuation swell and are now tasked with tackling the issues of portfolio company down rounds, shrinking cash runways, and a lack of liquidity to maximize interim fund returns and continue to capture LP commitments.”
The Pitchbook report also noted that the “increase in new managers over the past few years was a product of the strong interest in VC from LPs and contributed to a diversification of funds across the US market, bolstering smaller markets and non-hub capital availability.”
Because of poor market returns over the past couple years and the downsized appetite of LPs for emerging managers, Pitchbook says they “anticipate a sizeable portion of these first-time fund managers will be unable to raise a second fund and will exit the VC market, adding to the already falling supply of capital to the market.”
The Pitchbook report added that the US VC fundraising market “is in poor shape. 2023 closed with VC fundraising falling to its lowest point since 2017. LPs have become increasingly cautious regarding where they deploy capital and have retreated to the safe harbors of established managers.”
The report also mentioned that continued “concentration of capital within established manager-led funds has meant first-time fund managers face the harsh reality that there is less LP demand for their investment products.”
The report from Pitchbook concluded:
“In recent years, LPs that have committed capital to these managers, as well as startups that have received investments and the ecosystems in which these managers reside, have supported the decentralization and democratization of venture investing. The threatened recession of capital availability and risk appetite in smaller VC ecosystems is concerning because it has the potential to undo progress and stunt future growth.”