One of the biggest venture capital trends of the last few years was early-stage firms raising “opportunity” funds to make follow-on investments into their most successful bets. But amid a tougher fundraising market that impacts both VCs and startups, muted exit environment and slowdown in late-stage funding, will that trend continue?
Earlier this week, TechCrunch first reported that Lux Capital was raising money. What stood out was the firm ditching its opportunity fund and combining its early- and late-stage strategies into one vehicle that will mainly focus on early-stage deal-making. This came just weeks after Y Combinator announced it was pulling back from its late-stage strategy too.
At first, I thought these were just the first few indicators that 2023 would likely be the year the opportunity fund trend dies, but of course, it’s not that simple.
I think whether to raise an opportunity fund will become a much more debated question for firms looking to raise money this year. I think we will see significantly less of them, but there will still be firms raising them with good reason. Khosla Ventures and Canaan appear to be among these: Back in January, Khosla started fundraising for a slate of new funds, including an opportunity fund, and on Thursday, Canaan said it had raised $850 million across two funds, its flagship early-stage fund and a late-stage strategy, my colleague Connie Lozios reported.
For one, while there isn’t a lot of deal activity at the later stages right now, that doesn’t mean late-stage companies don’t and won’t need capital. Sure, some companies are overvalued, flush with cash and can wait out the muted exit market, but unless exits come back with a vengeance, a lot of startups won’t be able to do that.
Canaan general partner Maha Ibrahim told Connie that she sees great opportunity in having money set aside for the late stage right now because other investors don’t. Having this pool of capital gives them a distinct advantage over firms that don’t as they will be able to jump on the bright spots that emerge even in this tougher market.
Having funds on hand also allows firms to have the necessary capital to help their existing portfolio companies if they run into problems sourcing cash down the road.
Plus, venture is a long-term game. If a firm is out raising an opportunity fund now, it may take a few months or up to a year to collect the cash. Then, the firm will have three to five years to invest that capital.
The venture market will likely look entirely different in that amount of time. I don’t think anyone is predicting exit volume will stay at its current levels for the next five years. As activity starts to pick back up, the firms that choose to raise an opportunity fund now will have the resources to be active in a way those sitting out now may not.
But even though venture is a long game, I do think we will largely see funds looking to skip that strategy for their next fundraise, especially if they are hearing from their LPs that raising a late-stage fund won’t be an easy sell, as landing LP commitments has gotten more difficult.
There’s another factor to consider: Due to the stage-specific investing trends of the last year, multistage investors likely need to raise early-stage capital much more than they need late stage. Many firms that paused late-stage investing have continued to deploy healthy amounts of capital to younger startups.
Plus, even if a firm sees enough opportunity in its portfolio to justify having a dedicated follow-on fund, it just may not need that capital right now. Firms that raised opportunity funds over the last two years are still in their investing phase, and based on the muted late-stage activity of the last year, they may still have funds left over to deploy.
I think it’s likely that the funds that do ditch their dedicated late-stage fund will follow in Lux’s path and earmark a part of their earlier-stage fund for those opportunities. So while they aren’t on the hook to back a set amount of more mature startups, they will have the funds for the solid opportunities that do come up.
To raise an opportunity fund in 2023 or to not raise one this time around? That will be a big question for firms looking to fundraise this year and how they choose will have a big impact on the venture market for the next few years.