Sapphire Partners on how emerging VC funds can attract capital
While mega-funds may have raised their largest vehicles ever, the proportion of US VC capital going to emerging managers—that are investing out their first, second or third funds—hit a decade low in Q2, according to the latest NVCA-PitchBook Venture Monitor.
We spoke with Laura Thompson, a partner at Sapphire Partners, an LP arm within Sapphire Ventures, about the current fundraising environment, how emerging managers can grab LPs’ attention and why there is no one-size-fits-all strategy for marking down VC portfolio companies.
Sapphire Partners, which operates out of an evergreen vehicle, invests in early-stage established and emerging venture funds based in the US, Europe and Israel.
PitchBook: Despite the market downturn, 2022 has been a phenomenal year for venture fundraising. Did most of this fundraising start in 2021 or earlier?
Thompson: Funds with established LP bases don’t usually surprise LPs with fundraising. Yes, many of the fundraising processes started last year, even for the recently closed funds. However, most fundraising was from mega-funds and smaller established funds, which LPs always prioritize. When the market environment turns, as it has, LPs gravitate toward more established platforms because it gives them comfort. This is a big challenge for emerging managers.
How can emerging managers stand out in this market? It seems nearly impossible now.
As we go through pitch decks, many funds seem good. That’s why I think there’s nothing as powerful for LPs as references. The strongest references come from founders, GPs and other LPs. For instance, if a founder tells me, “I love this person. Here’s my direct kind of experience working with them,” that’s a powerful reference.
Also, it is such a crowded market now, there has to be something different about a new manager. Different comes in many flavors, and it is very LP-specific. For instance, we have been in Europe for a long time, but I know a bunch of LPs who want to build their European portfolios. I also think climate change is on top of everyone’s minds now, and some LPs feel they don’t have enough exposure to climate-focused funds. Ultimately, as a new manager, you need to show LPs how your fund will be additive to LPs’ portfolios.
What if you are an emerging manager that started fundraising this year? Will these funds be able to close their funds?
If you already know LPs, you’ve been having conversations for years and LPs are comfortable with your body of work, you might be fine. Or, if you are raising a smaller fund, that might be fine, too. It is also always easier to start a new fund when you are spinning out of an established fund. But if you are not doing one of those things, I think it will be quite tricky to raise now.
I understand that some traditional LPs, such as endowments, foundations and pension plans, may not have been able to re-up with all existing relationships that were raising funds this year. They were overallocated to venture, especially as the stock market dipped. As a fund-of-funds, you don’t need to manage your VC exposure against other asset classes. How did you deal with many firms coming back to market with larger funds this year?
In the past, we’ve invested with at least a couple of new funds a year. But this year, we had less bandwidth than we’ve had historically. With such so many re-ups, we had to prioritize our existing relationships.
Besides climate, are there any sectors or topics you feel don’t have enough attention from venture capitalists now?
When I look at the market, there aren’t that many holes. But one of the holes I see is small-sized funds. These are funds that are under $50 million. If you have a small fund, even if your ownership in each company is tiny, one strong exit can drive outsize returns.
Company valuations are clearly lower this year than they were last year. Are you seeing GPs mark down their existing investments? Are you expecting to see significant write downs?
Given the market has radically changed, managers should think carefully about their portfolio company valuations. If you are a new firm that only has seed and Series A companies, you could probably be less aggressive with markdowns.
But there’s no one right answer, which makes it tough for everyone. We’ve seen GPs mark down some of their companies by 25% to 50%. These could be companies that are performing really well but received their valuation in a different environment than today. And then there are some companies that have been impacted operationally, which might put them in a little more risk.
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