The State of Venture Capital: A look back at Q2 2023

With only 99 funds established, Q1 2023 was the worst quarter in over a decade with regard to new fund creation. Q2, however, presented a positive shift, with the number of new funds growing by 35% to reach 134, according to the latest data from Pitchbook. While we are still on track for the worst year in terms of the number of funds established since 2013, the quarter-to-quarter trend is encouraging, and we anticipate Q3 numbers to build upon the relatively stronger performance of Q2.

It’s worth noting that the increased number of funds and the total capital raised suggests a continuation of the ongoing trend where larger funds from established managers are being successfully raised while smaller funds from emerging managers face more challenges in attracting capital.

In Q1, the venture ecosystem experienced a major shock with the failure of Silicon Valley Bank (SVB), followed swiftly in early May by JPMorgan's acquisition of First Republic Bank (FRB). SVB and FRB were both pioneering banks in the venture space, playing a crucial role in facilitating funding for both funds and startups. Concerns were high for the venture banking sector in May, but as we enter Q3, the situation has stabilized, and now the competition is heating up among banks seeking to be the leaders in this post-shock environment.

First Citizens Bank acquired SVB's venture assets, making a strong push into this space. JPMorgan acquired FRB, with some FRB teams migrating to Citizens Bank (not to be confused with First Citizens). Other banks like HSBC Bank, Stifel, and Mitsubishi UFJ Financial Group (MUFG) have also actively sought out venture fund banking talent to establish their positions in this market, ultimately looking to serve VCs and startup companies.

Over the next few quarters, it will be interesting to see how fresh players at the table approach underwriting and lending in the VC space and how the teams already familiar with one another will perform within their new organizations. Given the higher interest rate environment, rates on capital call lines of credit now vary more widely, and more fund managers may choose to forego them, deciding that an increase in IRR and operational flexibility aren’t worth the added interest cost.

One might naturally assume that General Partners (GPs) would face pressure from their LPs to reduce management fees due to the slowdown in new fund activity and increased competition for capital. Surprisingly, this has not been the case. While fee structures for <$100MM managers still often exhibit creativity and uniqueness, in a conversation I had with Shane Goudey, a fund formation attorney at Cooley, he emphasized that for funds >$100M, "...2-2.5% with some sort of tail is still the norm as LPs look to build long-term relationships."

However, GPs are now “facing increased scrutiny regarding how management fees are utilized, particularly in terms of how salaries and expenses contribute to topline budget,” added Shane. With LPs keen on ensuring that managers can weather any downturn, GPs must now exhibit a coherent plan for expenses and team construction, even without the certainty of raising another fund within 18-36 months. This demonstrates the growing importance of management discipline for GPs.