Venture capital started 2022 as the hottest game in town. Strong LP fund performances lead to record inflows of capital, leaving VCs flush with cash to deploy.
As a result, startup fundraising rounds were competitive, sizable, and closed quickly. Armed with capital to utilize, these startups were able to show impressive growth and create a virtuous cycle by encouraging further investments from VCs. But the industry is now having to face a new reality with skyrocketing inflation, rising interest rates and geo-political tension.
Eric Tarczynski, is the founder and general partner at Contrary, a venture fund pioneering a talent-first approach to investing. Notable LPs include Reddit CEO Steve Huffman and Twitter CEO Parag Agrawal. Below he shares his thoughts on some of the most pressing questions the industry is grappling with.
Q: For VCs, what are the implications of coming off a record-breaking last five quarters of fundraising?
A: For an industry that didn’t change much in its first 60 years of existence, venture changed dramatically over the past 2-4 years. Capital and price became commoditized levers, competition became fierce,and founders, and entrepreneurs put renewed emphasis on the unique value firms and partners could add. We also saw the rise of the solo GP and crossover funds disrupting the venture ecosystem as a whole.
But the reality is that after two years of mayhem, the world has changed. For months, all people could talk about was the billions of dry powder raised last year and in early Q1. The real story is that the environment of the last two years won’t continue – we’re likely facing a long overdue recalibration of the venture capital asset class as a whole.
Later-stage startups in particular will take, in many cases, a couple of years to grow into their 2021 valuations. Overall capital inflow will slow given LPs are dramatically overextended, and the fever dream intensity of fundraising we’ve seen in recent years should cool off.
Q: How are LPs faring right now as they deal with a reset from the past year where large firms were able to continuously come back 2-3 times faster with 2-4 times larger funds?
A: With the markets in turmoil and valuations getting reset, many LPs are naturally feeling a bit overextended. Current lower public asset valuations have left some LPs with portfolios that are imbalanced and need to be recalibrated The current appetite for new managers is generally around early-stage and/or web3 firms, in addition to re-ups with top performers. We’ll see LPs sticking with GPs they have existing relationships with. It’ll be significantly harder for people raising first-time funds.
Q: What are the ramifications of overextended LPs – how will available capital be distributed?
A: The sad reality is that most available capital will go to some combination of cocktail party, multi-stage firms, more specialized firms, and firms with true differentiation for founders – emerging managers and crossovers will likely get hit the hardest.
It’s important to keep in mind that while there will be a pull-back, capital will still be available. Recalibration – as we saw in 2016, 2019, etc. – are necessary, and we continue to feel strongly that tech will be the best place to invest over the next decade.
Q: What does VC fundraising look like right now?
A: Many VCs are flush with cash after a record-breaking last five quarters, which should be good news for founders over the next 12 months.
But in an uncertain macro environment, while they’re sitting on cash, firms are also acting more cautiously and are slowing deployment given uncertainty about subsequent fundraises – it’s not clear how much capital will be available next time they fundraise.
Q: What will talent identification in the current climate look like?
A: The mission behind starting Contrary in 2016 was to identify and invest in the person rather than the idea. We wanted to build a community of the world’s most talented engineers, designers, and product minds – sometimes years before they started companies – understanding that if we helped them through their journeys, the opportunity to be their first check would be there.
We play the long game at Contrary, which ultimately positions us well in the current environment.
Because the reality is that great talent and ideas never stop – just look at ‘08 and ‘09, which brought us Uber, Airbnb, etc. – and Contrary will be there to support them every step of the way.
Sources:
https://www.ft.com/content/077de7e3-e4e3-49d5-8a76-3cbbc4f492f5
https://pitchbook.com/news/articles/vc-fundraising-venture-capital-asset-allocations-LP-GP-diligence
https://fortune.com/2022/05/10/vcs-term-sheet-readers-private-market-downturn/