“Tough Sledding” For New And “Marginal” Funds In 2016, Says LP

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Most institutional investors are notoriously circumspect. Chris Douvos is not like most institutional investors. In fact, Douvos, a managing director with Venture Investment Associates — a fund of funds group that commits capital to venture capital, growth capital, and private equity groups — is very opinionated comparatively.

It’s a refreshing quality, particularly when looking for insights into how the people who fund venture firms are feeling about the industry right now. And according to Douvos, they’re nervous, including because their venture customers are coming back to them a lot sooner for capital than they once did.

He explained during a chat on Friday, which we’ve lightly edited for length.

TC: There’s a lot of nervousness out there suddenly. Are you feeling it at VIA, or does it seem to you like this will pass?

CD: A lot of people are worried right now that we’re in a game of musical chairs, and no one wants to be standing when the music stops. People think that 80 to 90 percent of the billion dollar companies will end up getting liquid for less than a billion dollars, and I think there’s truth to that. We’ve been in a market where capital has been relatively cheap, and we’re looking ahead to a market where capital will get more expensive potentially.

TC: So VCs should be selling before things fall further? We wrote about secondary firms last week, and they say they’re getting a lot of calls.

CD: LPs are definitely yelling at VCs to put some ‘moolah in the coolah.’ They’re hammering their GPs to turn some of that [paper] value into actual cash because of what I call the exit sphincter. When the capital isn’t coming back [to institutional investors], it interrupts the flow of things. We give out money expecting it will come back with profits in a reasonable amount of time. When it doesn’t, we can’t put more money into the asset class because a.) we’re at the top of our allocation [to venture capital and b.) we’re out of money.

We have a down-trending public market at the same time that [our] private investments are really inflated [and not exiting], so LPs are getting doubly crushed.

TC: But you saw some money back. For example, one of your funds is True Ventures, which made an apparent fortune on its early check to Fitbit.

CD: We have seen money from Fitbit and there’s more on the way. We’re in some great funds. But now, all the funds we love are coming back in 2016.

TC: You make it sound like you’re surprised.

CD: As I look at my own portfolio, it’s fantastic: Data Collective, True [Ventures], First Round [Capital]. But as a result of these demands for new capital, it’s tough for new funds. It’s an industry-wide problem.

People invested faster than they have in the past. The fund deployment cycle has compressed from three or four years to two years as companies started to come back to market more frequently for more fundraises. It used to be that a round would last a company 18 months, but in the last couple of years, it’s been more like 12 months, so you shortened the latency of a funding round by a third.

TC: Does that aggravate you?

CD: It’s symptomatic of a pendulum swing in the direction of founders in recent years. Entitled founders plus founder-friendly VCs equals trouble for LPs. Founders saw opportunities to raise more money, frequently, at ever higher valuations, with less dilution. Meanwhile their VCs were getting a quick mark-up. The way companies have been getting financed also made it easier not to focus on business building, which is bad for everyone – employees, VCs, and LPs.

TC: What’s the bottom line? Think we’ll see the venture industry shrink further?

CD: I think we’re in a cycle with LPs where you’re not going to see a lot of new entrants. LPs are feeling tapped out, so I’d predict tough sledding for new funds, and that marginal funds will have trouble raising the same size funds that they’re accustomed to managing.

As for shrinking further, I think the great shedding of VCs that took place around 2008 really dated back to 1999 and 2000 [because each fund is invested over a 10-year period, roughly]. I don’t think we’ll see a comparable number of bodies this time, aside from associates falling out, including through natural attrition.