Why Hundreds of Venture Funds Could Turn Into Zombies

• Unlike startups, venture-capital firms do not suddenly go out of business.
• Their deaths can stretch over years or even decades.
• Many major LPs have committed nearly all their capital for the year, an expert said.

During the heady boom times of the past four years in the tech industry, more than 1,100 first-time venture funds were born, a record, according to PitchBook.

Now, with fundraising drying up and little to show in the way of meaningful returns, many of those funds face a harsh reckoning.

Unlike the startups they fund, venture firms do not suddenly go out of business. They face a more agonizing death that can stretch over years or even decades. Unable to raise new capital, they slowly bleed staff, coasting on management fees while trying to salvage whatever they can of the investments they have already made.

“There’s going to be a lot of walking dead venture firms,” predicted Jake Saper, a general partner at Emergence Capital. “If you don’t raise another fund, you’re resigning. It’s just a matter of time before you’re dead.”

The denominator effect

Limited partners, known as LPs — the endowments, pension funds, foundations, and wealthy individuals that fuel venture firms — committed a record $128.3 billion into VC funds last year, according to PitchBook, a major increase from the previous year’s record-setting $86.9 billion. But that free-flowing money spigot is likely to slow to a trickle for several reasons, some of which have nothing to do with how startups perform.

One is the so-called denominator effect. LPs usually allocate their total assets in a variety of financial instruments, including venture capital in the private markets, hedge funds in the public markets, and private equity. With public stocks and other parts of their portfolio down sharply, LP allocations in these areas are out of whack — they suddenly have much more of their total assets put into to venture than they are allowed, meaning they have to dial that exposure back and invest less in venture capital.

“That’s just the math, and unless the public market responds really quickly or the LPs completely change their asset-allocation strategy, this is going to happen,” Saper said.

Making matters worse, even before markets tanked, many major LPs had already committed nearly all their capital for the year to big multiplatform VC firms like Andreessen Horowitz and Sequoia, according to Beezer Clarkson, a partner at Sapphire Ventures who created OpenLP.

“What we were hearing from LPs is they were already out of allocation by April of this year, because they had come into these funds and done so much,” Clarkson said. “The question that we’ll be looking at is in the second half of the year, who is able to raise when people are making more budget-constrained decisions because of having already spent a lot of their budget?”

The ‘Walking Dead’ sequel

VCs usually love being on lists — but during the Great

Recession

in 2009, the journalist Dan Primack, now at Axios, maintained a list called “The VC Walking Dead” that no one wanted to be on. It included names like BluePrint Ventures and Diamondhead Ventures that have long since been forgotten.

This time around, the carnage could be much worse, considering the sheer number of new funds started in the past few years: an average of 221 a year from 2017 to 2021, versus 53 a year from 2005 to 2007, according to PitchBook.

A big difference in this recent boom is the furious pace VCs raised at during the past few years. With so many LPs eager to write checks, venture firms raised new funds as often as every year rather than every few years.

“LPs will say, ‘Look, I gave you money last year and the year before and the year before, and there’s just no more money right now,'” Saper said, adding that without a new fund to deploy, firms will slowly shrink. “The best talent will leave because they want to make new investments and continue to grow.”

Venture is a long game, often taking upwards of a decade to determine whether early bets on startups pay off. Any fund that raised in the past few years will have a hard time putting wins on the board, especially if the market continues to contract and the IPO market remains frozen.

“If you raised a fund in 2020, you did great on paper, but now all your valuations are actually much lower, and you’ve never really figured out how to help a company through a downturn and then have to go out and raise a new fund — that’s going to be hard, because you won’t have the markups,” said Mar Hershenson, a founding managing partner at Pear VC. “Then you’ll be called a zombie VC.”

A heavy dose of schadenfreude

VCs who have been in the business a long time are feeling schadenfreude as they see a comeuppance for people far better at raising capital than investing it.

“Consistently performing a fund to return a lot of capital to LPs over decades is a very, very difficult job,” said Pejman Nozad, a cofounder and managing partner at Pear Ventures who famously arrived in the US with only $700 and worked his way up from selling rugs to managing a portfolio now worth more than $20 billion. “If you look at the last 50 years, only a few firms could have done it.”

As Nozad and other more experienced VCs are fond of pointing out, they have seen both good times and bad, while newer VCs have experienced only the boom times.

“The last few years made it look easy because of so much capital out there,” Nozad said. “It’s not easy.”

Some argue that having one’s back against the wall is not necessarily a bad thing — that there’s nothing like being among the walking dead to provide the focus and motivation to find an investment that can bring a VC fund back to life.

“I actually made some of my best investments when I was dead,” said one Bay Area VC who was included on Primack’s “Walking Dead” list after the firm did not raise a new fund for five years.

Do you know of a venture firm no longer investing or in trouble? Contact reporter Ben Bergman at bbergman@insider.com to anonymously share your story.