The coming rise of venture funds-of-funds

Mid-sized VC firms are going away, but some former GPs might find a job managing LP money.

As endowments and pension funds tighten the spigot on alternative investments, they’ll be focusing on VC megafunds and boutiques, leaving the mid-sized firms to starve or reconstitute themselves.

Last week, three VCs said us as much, and today NVCA president Marc Heesen confirmed the same on a call with VatorNews. “What I’ve been talking about for several years is the growing barbell in the industry […] There will be a few venture funds that are geographically agnostic, stage agnostic, industry agnostic that are going to play in lots of different areas; and simultaneously there are lots of firms that are regionally specific, industry specific, and small in size.” There’s a place for giants and dwarves, but anything in the middle is in danger. “The LPs are looking at these mid-level firms and saying, ‘you’re trying to be all things to all people. What are you exactly? You don’t have the track record or the personnel yet to become a megafund, but you’re trying to do too many things, so you have to make a choice.”

Where will all those mid-level VCs go? Turns out LPs may have another job for some of them. Venture capital is a miniscule portion of an LP’s portfolio, and state personnel staffs are shrinking. That means less due diligence. Last week, Richard Yen told me at an SDForum event that LPs will write fewer checks simply because it’s easier.

But “easier” doesn’t mean better returns. This could be a problem. “That’s right,” Heesen told me. “If anything, you have to be concerned there, in the respect that many of these megafunds co-invest with one another, they’re all located in the same geographic region, and you kind of look and say, ‘Am I investing in the same fund?’”

On Monday, Michael Kim announced he’d be leaving Rustic Canyon Partners to managing a $250 million fund of funds. That announcement, by the way, probably explains why he wasn’t on the panel with Yen at the SDForum, as scheduled. I mentioned the fund-of-funds phenomenon as a potential solution to Heesen; maybe LPs should outsource their check-writing.

“Exactly. And I think funds of funds become more important as firms get smaller, because, like you say, they don’t have the ability to be looking at all those firms. […] If you have fewer people watching the endowment dollars, let’s say, you’re going to need some outside help, and I think funds of funds actually become more important down the line.”