Venture capital’s banner year masks diverging sector

A handful of top venture-capital firms raised massive funds of $1 billion and more, which propelled the sector to set new records for the year. Collectively, firms raised more capital than ever before and deployed it at a stunning clip during an economic upheaval that many in March predicted would chill the industry.

But that success largely was felt among the top echelons of industry players. Small and medium-size venture funds, which historically have played a crucial role in supporting the overall sector, faced a different reality.

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The number of sub-$500 million funds raised is on pace to fall 35% to 247 by year’s end compared with last year, according to a WSJ Pro analysis of data from PitchBook Data Inc. and the National Venture Capital Association. Meanwhile, the number of funds that raised over $500 million is on pace to jump 96% compared with last year to 47.

The shift is a departure from the past decade, during which each year small- and medium-size funds accounted for roughly half of the overall capital raised in the venture industry. This year, those funds are on pace to account for only one-third of the industry’s total fundraising haul, according to PitchBook and NVCA.

Although the year’s large initial public offerings will shower firms big and small with cash, their ability to start new funds was more divided.

The sea change is likely to affect entrepreneurs not already looped into Silicon Valley’s insider circles, ultimately dampening innovation, investors and technologists say. New founders already have said the pandemic has raised the barriers to entry.

The potential loss comes as the U.S. has filed lawsuits alleging technology giants including Facebook Inc. have stifled startup innovation, a charge those companies broadly deny.

Limited partners, which often include institutional investment firms, public pension systems and family offices, commit capital to venture funds with hopes of a payout down the line as portfolio companies reach public markets or get purchased. Some of these LPs pivoted to big name-brand firms when the pandemic hit, small fund investors said. Unlike large firms, smaller and newer firms often times rely on more investors to supply them with capital. Many are wealthy individuals and family offices that were hammered by the pandemic, investors said.

Many small and medium-size firms ultimately postponed raising new funds.

“The megafunds have been soaking up the money," said Homan Yuen, a partner at venture firm Fusion Fund, which was started in 2015 and invests out of an $80 million fund. “It ripples through the ecosystem."

Other similar size firms have seen investors shift to larger firms because they view them as safer bets, Mr. Yuen said. Also, LPs are less willing to rely on virtual due diligence for lesser-known firms, Mr. Yuen added.

Mr. Yuen declined to comment on Fusion’s own fundraising, citing Securities and Exchange Commission regulations that prohibit investors from making public statements about such efforts.

After stints at established venture firms, Charlie O’Donnell launched his own small outfit in 2012. The firm, Brooklyn Bridge Ventures, taps wealthy individuals and family offices to raise funds that are under $20 million.

Mr. O’Donnell said he has struggled to raise his third fund, in part because a number of his investors have retrenched amid the pandemic. Many of his New York-based backers have real estate holdings that have suffered and told him their cash positions were too unpredictable to commit to his new fund, Mr. O’Donnell added.

“Those people have basically disappeared," Mr. O’Donnell said. “Noninstitutional holders are really hard to raise from this year."

One illustration of investors’ shifting strategy is with the Los Angeles City Employees’ Retirement System, which had roughly $645 million committed to venture capital as of June. In each of the past several years, the pension system made capital commitments to venture funds in a range of sizes, including to newer firms, according to department financial statements. In contrast, through June of this year, the most recent information available, Lacers made only one venture commitment: roughly $38 million to three General Catalyst funds that totaled $2.3 billion, according to the statements.

Lacers Chief Investment Officer Rodney June declined to comment on the investments but pointed to a November report which stated Lacers would “continue consolidating commitments with top performing managers."

To be sure, there were success stories this year for small new funds.

As the managing director of Heartland Ventures, Max Brickman helped the firm raise its debut $15 million fund three-and-a-half years ago to target technologies in sectors such as manufacturing. The pandemic has been a boon to some of Heartland’s investors, including makers of recreational vehicles and pontoon boats. As a result, the Columbus, Ohio-based firm is ahead of schedule in raising its second fund, Mr. Brickman said.

Still, the continued rise of megafunds was a signature of 2020. During the pandemic, Andreessen Horowitz raised a pair of funds that in total raised $4.5 billion, an amount unheard of several years ago.

In June, Greylock Partners, one of Silicon Valley’s oldest venture firms, notified its LPs it would begin a new fundraising effort, said Greylock Partner Asheem Chandna. Within weeks, it had raised a $1 billion oversubscribed fund.

“We’re very fortunate fundraising was smooth and went quickly," Mr. Chandna said. “We had a few conversations over Zoom and we were basically done. There was really no difference from the past."

Mr. Chandna cited Greylock’s relationships with a small number of investors, such as Princeton University, that it has cultivated since the firm was founded in 1965.

For Signia Venture Partners, a young Menlo Park, Calif.-based firm, its test likely will come next year. The firm is planning to raise a new fund to follow up on the $85 million it raised in 2019.

“It could be tenuous," said Signia Partner Linus Liang. “There’s no guarantee all LPs will be back."

This story has been published from a wire agency feed without modifications to the text.