Another big raise. It says to me that the VC's have a seller's market right now, in that a lot of limiteds are throwing money at the VC's expecting the Unicorn Ranch to keep producing. I'm not sure where $4B-$8B in recent raises is going to go. They are going to be hard pressed to find enough rat-holes to stuff that much money into. Of course, the Unicorn bubble could continue, but at some point I'm thinking valuations are going to reconnect with revenues, and then what?
They probably have 10 years to deploy the capital though with any fund they have to invest some each year to keep up with the IRR they aim to provide for their LP's.
"they have to invest some each year to keep up with the IRR they aim to provide for their LP's"
Assuming that VCs measure IRR in the same way as other Private Equity (i.e. based on capital calls and capital distributions), then you don't need to deploy capital early to maximise IRR.
For example, let's say a fund had a 10 year life and commitments of $10bn:
- Years 1 to 9: no capital calls, and no investments
- Year 10, 1st Jan: 10MM called and invested
- Year 11, 1st Jan: 15MM received from liquidating the investment, and immediately returned to LPs. Fund closed.
The cash flows are {0,0,0,0,0,0,0,0,0,-10MM,+15MM}.
The IRR of those flows is 50%, which sounds pretty decent, except that:
- The LPs capital was deployed for only a year
- Even for that year, only 1/1000th of the committed capital was called and deployed
So, the VC fund's performance (measured by IRR alone) looks good, but the LPs paid fees for nothing. They had to manage 99.9% of the cash themselves for the whole time.
> They probably have 10 years to deploy the capital
They probably have about that much time to return the capital. 10-year fund doesn't mean you get to keep 10% of the capital in a box for a decade (apart from reserving for management fees).
There's heterogeneity in the "they" we're referring to. As a rule, no, funds do not reserve capital for follow-on rounds. A venture fund's cost of capital (i.e. expected return) is high, making the compounding cost of holding cash cumbersome.
Instead, a firm will generally raise one fund for early-stage (e.g. seed) and another, either later or if they have a strong pipeline concurrently, for later investments (e.g. A), where preference is given by the latter to companies invested in by the former.
1. The funds don't "hold cash" for follow ons. They "reserve capital" which is subsequently called. There's no dead weight uninvested cash drag on irr (or properly, very little of such).
2. "Crossover" investments between funds are generally frowned upon, although the pendulum swings on that practice and more recently it seems they are in favor again. Still, it is the exception rather than the rule that the same manager (VC X) is allowed / supposed to put money from two different funds (X fund I and X fund II) into subsequent series of the same company's stock. If you think about it, that makes a ton of sense because in downside cases, VC X may then have to play King Solomon and split the baby between its Fund I and Fund II investors, both of whom it has a fiduciary duty to, hence a conflict it's best to avoid altogether. Now, that is a problem that comes up in downside cases and recent times have been good, so once again people are overlooking the conflicts in the name of keeping the punchbowl full and spiked.
3. Funds do most definitely reserve for and participate in pro rata follow ons in subsequent rounds. 100% of market early stage A/B/C term sheets will ask for pro rata rights (for follow ons). If you don't have follow on reserves you risk facing a "pay to play" or other punitive term in a future round (again only in the downside cases which people start to neglect in the up cycle times like the last 2-3 yrs).
Then they failed. In the same way as a startup that raised $x in VC and after burning through 50% decided that it didn't work and give the money back would be considered as failed.
Investors invest because they expect a certain return. Doesn't matter if it's VCs investing in startups or LPs investing in VCs.
In case you're wondering if they would have to give the money back: Technically, they don't have all the money. VCs 'request' money over time from their LPs (they do 'capital calls').
