Here for a good time, not a long time: an early look at 2022 VC fund returns

Next came broader indices falling into bear market territory along with a flight from fixed income markets.

Now, LPs’ VC portfolios may be the next target of persistent inflation, rising interest rates, and slowing economic growth.

VC funds saw a nearly unprecedented run of strong returns from the pandemic-induced lows to the end of 2021, helping the asset class outpace all major private fund strategies over recent history.

However, nearly two-thirds of the quarterly returns for VC from Q2 2020 through Q3 2021 have come from unrealized values on average; a period only surpassed by the dot-com run-up.

With the comp sets of tech companies in public markets seeing a reset in valuations over the last year, it’s highly probable that current fund net asset values see a haircut soon.

Our first, way-too-early look at VC fund returns suggests some of that haircut has started.

Preliminary data for Q1 2022 indicates that 68.1% of reporting VC funds had a drop in valuations from their 2021 peak, a multi-year high mark. Of those funds with a markdown, the median drop was -7.8%.

If the data holds after further collection, a material slump in LPs’ allocations will be likely for the roughly $1.4 trillion in unrealized VC fund value from the end of 2021.

Further markdowns are probable given that the market environment has continued to deteriorate through the second quarter as well.

The VC dealmaking environment will present a headwind for current startup valuations the longer the liquidity crunch lasts. Startups are tightening belts to avoid down rounds, but when the cash from a prior fundraise dwindles, stale valuations from last year will be tested.

Fortunately, a normalization of deal terms and valuations is probably healthy for the market in the long run. If recessionary pressures dissipate sooner than anticipated, a dawn of a new cycle will likely be on the horizon.

Our new research on the current macro environment dives into these themes in detail. Download the free note: Did VC Fly Too Close to the Sun?

Don’t hesitate to reach out if you have any questions or would like to discuss further.