VCs Must Woo Unhappy Investors, Too

The latest tale of woe out of the VC industry appears today in the Wall Street Journal, on how the limited partners who invest in venture capital firms are backing out of their commitments to fund individual VC funds. The end result of LPs failing to follow through are shuttered companies such as Ambric, which had to close despite having signed several customer deals and keeping its investors’ confidence. But when the investor’s investors back out, the money dries up.

Unlike the last technology bubble, when LPs questioned how much money they put into venture capital as an asset class, this time around there are questions about both the viability of the asset class and pressure on all alternative investments. Right now the venture industry is stuck between an inability to get money out of their investments through public offerings and M&A and the inability to get money into their investments through new investments into funds.

Venture funds are part of an asset class known as alternative assets, which typically can generate high returns over a long period of time. However, in many of these cases the assets are illiquid and require a pretty detailed understanding of a market. Because alternative assets — which include real estate, oil and gas, venture capital funds and hedge funds — are so complex, most limited partners only allocate a small percentage of their overall investments to them. During this financial crisis limited partners are getting squeezed as the value of more common assets such as stocks go down, causing the percentage of money allocated to alternative assets in their portfolio to rise.

As that happens, they suddenly find themselves needing to rebalance their portfolios. To that end, some are opting to see a portion of those assets on the secondary market and and to halt new commitments, but as the Wall Street Journal details, they are also defaulting on their capital calls. Because this time around, the entire LP portfolio is taking a hit, which means a recovery in VC investment will also require a recovery in all other investments. While we wait, expect the total number of VC firms to shrink — something many in the industry have been arguing for, anyhow.