17 February 2023 |

LP’s Are Pissed Off, & Rightfully So


My wife and co GP Stevie is an LP in a few funds. If it comes up she will absolutely remind you—because of how pissed off she is about it.

Not all LP’s are created equally—Stevie decided to be an LP because she was told it was a great way for women to get generational wealth. And, yet, a few years later, a lot of her funds aren’t performing as well as her or the GP expected.

It’s not just the funds she invested in, and it’s not just her—we’ve had frank conversation with our LP’s, who have shared how disappointed they are in fund managers they invest in. A lot of them have exposure to crypto funds—some of which have apparently went silent to their LP’s for 2-3 weeks after FTX. Others feel misled, after hearing about how fund managers will talk about how most of their fund was marked up, they’re now hearing about fund managers marking down portfolio’s aggressively. In the startup ecosystem, you always assume something you’re investing in is going to go to 0, whether its a startup or fund. But you rarely assume that the company’s chances of failing increases after you cut a check—for many LP’s that’s exactly what’s been happening over the last few years.

This disappointment is being felt across the board. Why? Well actual returns—money sent back to LP’s, also known as distributions—absolutely suck in the venture ecosystem. According to a new Silicon Valley Bank report, between 2005 and 2015, 16% of funds have a negative internal rate of return (IRR, a core metric in assessing an investors performance.) NEGATIVE! As in they are losing their LP’s money! And this isn’t an outlier either—53% of funds produce an IRR between 0-20%. Considering the industry benchmark for IRR is 20%, 69% of VC fund returns between 05 & 2015 performed below the industry benchmark.

And this was before the massive VC fund bubble we’re in now—yes, democratizing investing is important but creating fund managers out of any Joe Schmo from Harvard can create some negative long term effects. And it looks like the chickens are coming home to roost, in the form of TVPI.

TVPI is the total value of paid-in capital, and DPI is the distribution of paid-in capital. In laymans terms, TVPI includes markups and the paper value increase funds show to potential investors, but DPI is the actual dollar amount that was distributed back to Limited Partners. And again, the data is abysmal. Vintages from 2010 show a massive TVPI return—often above 2.5x, which is incredible—but the actual DPI hovers around 1x (meaning the fund’s just breaking even) and from 2014-2022, the median DPI doesn’t even break even.

And, SVB predicts, with 92% of US VC-backed IPO’s since 2022 trading under their IPO price, DPI “will likely come in well below current TVPI levels.” Meaning the amount that fund managers are projecting will go back to LP’s will probably be way lower than what fund managers & LP’s are saying and expecting right now.

So, LP’s are pissed, and rightfully so. VC’s are taking LP’s capital and pretty much flushing it down the toilet.

Anecdotally, LP’s are really annoyed by all these data points and indicators showing how atrocious venture capital is as an asset class. And with rising rates, LP’s will definitely choose to pause or pull back the percentage of allocation they’re dedicating to venture. With the risk-free rate of return going up 225 basis points last year, and not projected to go down anytime soon, LP’s can sit on the sidelines and wait it out until better times come around.

At the end of the day, a lot of the issue here is with venture itself. VC’s are trained to think about power laws—the fact that most of your fund will be returned by 1 or a few investments. That has created a sort of power law effect in venture capital as well; 31% of funds between 05 & 2015 have a IRR above 20%, and the top 10% returned 35%+ IRR.

Over time, LP’s will start holding out for allocation into the best performing funds, and nothing else. And over time, that’ll cause a lot of funds to evaporate.