In Q1 of 2022, US VCs raised at an unparalleled rate. According to Pitchbook, more money was raised for new funds in this quarter than in the entirety of 2019.
However, this significant fundraising doesn’t exactly line up with the number of VC investments. We’ve seen a significant decrease in VC investments in Q1 of 2022. So while LPs may be slowing down, VC investments are expected to remain relatively stable due to the record-high amount of dry powder the market has ever seen.
Public market trends have historically been a good indicator of venture activity. Because of that, some believe VCs may face headwinds given the current movement of public markets.
But we predict that VCs, solo capitalists and angel investors will find opportunities in these 3 areas:
- Microfunds & SPVs
- Seed Deals & Secondary SPVs
Micro-funds continue to be a rapidly growing vehicle.
The number of microfunds closed has grown from a tepid average of 75 per year between 2006 and 20011 to 320 between 2018 and 2020. And a record 339 micro-funds were closed in 2021.
Fund managers and solo capitalists use micro-funds and SPVs as a vehicle to adapt to the changing landscape and access new markets faster than ever. So as public markets remain in uncertainty, we expect to see even more fund managers take advantage of micro-funds and SPVs.
This April, Pitchbook released a report analyzing micro-funds and the direction they are trending:
“Despite the growing divide between micro-funds and the vehicles that drive the majority of venture fundraising in the US, these smaller vehicles have continued to drive trends from the beginnings of venture, and we believe they will continue to do so. Not only do they provide capital to the youngest companies, but they also offer benefits to the industry that larger funds cannot.”
SPVs and micro-funds create opportunities for solo capitalists and emerging VCs, providing access to more deals and allowing diversification.
“Micro-funds continue to proliferate in venture because, in many ways, they help democratize VC. Whether it be through increased opportunities to access the investment strategy, raise capital, or grow an investment firm or VC ecosystem, micro-funds offer keys to many.”
Historically, micro-funds and SPVs are most often raised by emerging managers. (Typically 60% of micro-funds—and in some years, more than 75%—are raised by emerging managers). But since 2011, we’ve seen a steady uptick in more established managers raising micro funds and SPVs.
However, it’s not only fund managers and investors who benefit from these smaller vehicles. There is a huge upside for founders and startups as well.
How are founders benefitting from SPVs?
Given that SPVs increase access to investors of all sizes, Founders are able to:
- Invite small-check investors
- Maintain their cap table in an efficient manner
- Take the lead in ‘rolling-up’ their investors into an SPV
For example, Clubhouse in its recent Series B announcement, shared that it has over 180 investors in the company - many of which are small, independent investors that fit on a single-line on their cap table).
Micro-funds and SPVs often are most impactful at the seed stage- it allows emerging fund managers to engage more actively with founders while also diversifying.
It's important to note the strong correlation between micro-funds and seed deals. And in 2022, we are continuing to see VCs pour capital into seed stage deals.
With angel and seed stage companies being furthest away from public markets, it’s likely there will be a high level of activity in early stage deals.
According to CB Insights early-stage deals continue to account for the majority of deals (60%) in 2022 YTD.
With the heavy focus on seed / angel investments, SPVs will help fund managers get deals done quickly in these early stage investments. Founders move quickly, especially when the company is at the seed stage of funding. Angel groups and fund managers will lean on SPVs to keep up and avoid missing out on deals.
Large VCs have already started to allocate a portion of their capital to seed deals. In 2021, Andressen Horowitz raised a $400M fund specifically for seed deals and Greylock announced a $500M fund dedicated to seed investing.
“We are seeing later-stage firms move earlier as they recognize the opportunity in seed.” says Sarah Hodges, a partner at Pillar VC.
Fund managers will also likely look to secondary SPVs. This is where investors purchase existing shares from current shareholders in a company.
Why would shareholders sell early?
With the public markets unstable, many private companies will likely remain private longer than expected. Shareholders who are looking to liquidate quickly can do so though secondaries.This creates a valuable opportunity for fund managers and investors to invest in companies they may have previously missed the opportunity on.
And of course, it would be impossible to discuss the trends of 2022 without mentioning crypto.
We’ve already seen VC firms increasingly back more crypto projects, and especially with institutional adoption of crypto on the rise, we expect to see fundraising for crypto startups continue to grow.
VC funding for crypto startups grew in Q1’22 for the 7th quarter.
The pullback in crypto prices have some fund managers feeling skeptical. But those who are in it for the long haul (aka: HODLers) will continue to allocate to early stage crypto startups.
“Venture funding to blockchain startups grew for the 7th straight quarter. While most other sectors saw Q1’22 declines due to lackluster public markets and an unsteady economy, VCs doubled down on blockchain and crypto. Web3, including NFTs and DeFi, was the biggest driver of growth.” (CB insights
So what does this mean for private markets?
Even though public markets face uncertainty, it's unlikely that VC activity will slow down completely, as there are billions in dry powder yet to be deployed. Valuations and deal sizes may normalize, but Founders will still build and raise and deals will still be done.
LPs will lean on SPVs as more opportunities arise.
Investors and Fund Managers are usually adaptive to such markets and find flexible and opportunistic ways to back the Founders and startups they believe in.
SPVs act as an extremely flexible tool, for such emerging managers and their investors, to raise and invest in opportunities on a deal-by-deal basis.
- Total new SPVs will increase as more opportunities arise
- Secondary SPV demand will increase
- Micro- fund and SPV demand will increase
- LP preference will shift more towards SPVs than Funds
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Disclaimer: The information provided in this document does not, and is not intended to, constitute legal, tax, investment, or accounting advice; instead, all information, content, and materials available are for general informational or educational purposes only and it represents the personal view of the author. Please consult with your own legal, accounting or tax professionals.