2022 isn’t a repeat of 2002 for VC funds

Twenty years ago, I sat down in a Boston lobster shack with a college endowment manager who looked equal parts dazed and triumphant. “They’re really going to give the money back,” he said before we’d even been offered water. “Can you f**king believe it?”

Fast forward: 2022 is not 2002.

Backstory: My lunch was shortly after the dotcom crash. VC funds had raised record amounts of cash, predicated on a belief that both the number of tech startups and tech startup valuations would continue to grow.

• Instead, their existing portfolios were hemorrhaging and their limited partners were panicked. Several brand-name firms essentially cut the sizes of funds they had already raised — usually in the 20–50% range — determining that such large sums couldn’t be responsibly invested. Some did so voluntarily, while others did so under intense LP pressure.
• Most firms that reduced fund sizes and survived the carnage would be rewarded in future fundraises by appreciative LPs. Some of those that clung to their committed management fees were not so fortunate.

That era’s VC fund cuts, which weren’t mirrored by private equity, have seeped into this year’s social media conversations. And it makes some sense, against the backdrop of record VC fundraising numbers and the tech stock rout.

• But I’ve yet to find any limited partner who expects a redux, or even is agitating for one. Some reasons:

1. Passivity. We’ve discussed at length how many of this generation’s venture capitalists have never dealt with a lengthy downturn, but it’s also true of many of this generation’s limited partners. VC funds have generated huge returns for over a decade, so newer LPs are most adept at opening checkbooks and simply asking “How big a number can I write?”

2. Timeline: Even for more experienced LPs, a washout of 2021-vintage funds won’t be as painful as the dotcom-vintage funds may have been, because VC fund lifecycles have shrunk from three–four years to one–two years. And, for GPs, there’s less incentive to reset the clock.

• One wrinkle here, however, is that fund life cycles may expand on their own, particularly if denominator effects make fundraising more difficult.

3. Dry powder: LPs won’t even consider pressuring VC fund managers until they see major markdowns and/or write-offs, and the massive amount of existing fund capital (particularly in the growth stages) could paradoxically prop up valuations for some time to come.

4. Tech maturity: “Internet” tech was still fairly new in 2002, so the crash caused many potential founders (and investors) to question whether launching a new company even made sense. Thus, a major deal-flow deterioration for VC funds. Today, there are no such doubts.

The bottom line: We’re just at the beginning of what may be a multi-year correction. Or maybe just a blip that we’ll laugh about by Labor Day. Either way, we’re not close to that brief moment when VC funds were giving back more than they were taking in.